The Euro traded as low as 1.204 EUR/USD against the U.S. Dollar on July 24, 2012, but has since risen by as much as 9.39% to reach its September 17, 2012 high of 1.317 EUR/USD. Although it has pulled back to 1.298 EUR/USD as of September 21, 2012, could continued recent strength by the Euro, coupled with recent weakness in the U.S. Dollar (whereby the USD index, comprised of a basket of currencies, has depreciated 6.53% from 84.10 on July 24, 2012 to 78.60 on September 14, 2012) boost favorite technology stock Apple (AAPL) ?
EUR/USD FX Spot Rate 6-Months Chart - Source: CNBC.com
U.S. Dollar Index 6-Months Chart - Source: CNBC.com
Naturally, it would be expected that dollar denominated international revenues would get a boost in a weak dollar environment. However, whether such boost would record any material impact on net revenues is also dependent on each company's hedging techniques, pricing strategy, as well as international demand growth for its products and services.
In case a company is actively engaged in hedging 100% of its currency exposure in the forward FX market, then the effect of currency fluctuations should be negligible. From a practical perspective, it is highly unlikely that any company would engage in attempting to hedge 100% of its currency exposure, as it would possibly leave itself exposed to having overestimated its expected future revenue stream, and hence would expose itself to possible losses on its hedges. Furthermore, a company also needs to take into account its international expenses which would actually increase (on a USD basis) in a depreciating dollar environment; hence currency hedging needs to carefully examine net exposure, taking margins into account, international revenues, and isolating foreign expenses (such as international suppliers, wages, administrative expenses, etc...)
Pricing strategy for a company's products and services also has an effect on a company's U.S. Dollar denominated revenues. In case a company prices its products in U.S. Dollars, and adjusts its foreign currency price depending on the exchange rate, then the direct effect of currency fluctuations will naturally be mitigated. On the other hand, as the foreign currency denominated price will fluctuate, then as per economics 101, one would expect demand and ultimate quantity of sales to be affected, whereby a higher price would lead to less demand and vice-versa (with the magnitude/sensitivity of such relationship depending on the elasticity of demand).
It is also important to note that although the dollar has dropped noticeably during the past several weeks, such move is less extreme when examined form the end of the last quarter on June 30, 2012. That is due to the fact that the dollar had actually appreciated during the first three weeks of July. Hence, from the end of June, the Euro has actually appreciated by about 2.53% from 1.266 EUR/USD on June 29, 2012 to 1.298 EUR/USD on September 21, 2012, while the dollar index depreciated by 2.75% from 81.63 on June 29, 2012 to 79.38 on September 21, 2012.
Finally, when examining the effect of currency fluctuations on quarterly earnings, it is not only the end points that matter (exchange rates at beginning and end of quarter), but also the average daily exchange rate during the quarter, the methodology utilized by a company to convert its international revenues to U.S. dollars, as well as the timing of its hedging transactions throughout the quarter.
In its latest earnings release, Apple reported net earnings of $8.8 billion on revenues of $35 billion for its Q3 2012 quarter ending June 30, 2012. Apple's international revenues were 62% of its total revenues, while its margin was 42.8%. Apple's healthy margins, coupled with its large percentage of international sales, mean that its U.S. dollar denominated sales and revenues would benefit in a depreciating dollar environment. The magnitude of such effect would be offset by Apple's hedging techniques.
As Apple has continued to experience growth in its U.S. and international markets, this would imply that in an environment of appreciating U.S. dollar, the resulting negative effect on Apple's profitability would be somewhat offset by its increasing absolute unit sales. Meanwhile, in a depreciating dollar environment, Apple would benefit both from a lower dollar, as well as increased unit sales. Naturally, that would also depend on the way that Apple has structures its international contracts with its suppliers, and whether such contracts were actually denominated in USD or in the foreign currency, and whether such contracts had any foreign exchange contingencies.
Apple had actually announced that its revenues were reduced by about $200 million net of hedges during last quarter due to dollar strength, and it had expected dollar strength to continue for the quarter ending September 30, 2012, resulting in a further reduction of $400 million net of hedges in its revenues for the current quarter. As the dollar has actually depreciated by about 2.75% so far this quarter, and depending on where such exchange rate ends up on September 30, it seems that Apple has actually underestimated its current quarterly revenues; however, this would also depend on how Apple conducted its hedges, and whether it had entered into substantial dollar related transactions during the first 3 weeks of July (when the dollar was strong) in order to achieve its quarterly hedging targets. In such case, Apple would not fully capture the benefits of the recent depreciation of the dollar. Nevertheless, a depreciating dollar is clearly in Apple's favor, and as long as the Euro maintains its current levels or appreciates further in the future, Apple's earnings would be expected to get a boost.
It is virtually impossible to calculate perfectly Apple's sensitivity to the dollar exchange rate without having substantial details of country by country exposure, supplier by supplier contract details, hedging strategy and techniques, etc... However, we can still attempt to derive a somewhat crude estimate. With 62% of its revenues driven by international sales, Apple's international quarterly revenues would be $21.7 billion. Using a margin of 42.8%, that would yield a U.S. dollar sensitivity of $92.9 million per 1% move in the value of the dollar. Assuming Apple engages in hedging 50% of its exposure, then its sensitivity would be about $46.5 million per 1% move in the value of the dollar.
If we examine Apple's performance during last quarter, it had said that its revenues were diminished by $200 million due to the stronger dollar. During such period, the dollar index had appreciated by about 3.5% from about 79 on March 30, 2012 to 81.80 on June 30, 2012. That would yield a sensitivity of about $57.14 million per 1% change in the value of the dollar. That is actually very close to the hypothetical sensitivity of $46.5 million that we had calculated. The difference is due to all those details for which we do not have the privilege of knowing, such as the percent of hedges used, currency by currency sensitivity, etc...
Given the fact that the dollar has actually depreciated by about 2.75% so far this quarter, then one would expect Apple's earnings for this quarter to actually benefit by no less than $125 million due to the dollar, as opposed to diminish by Apple's own estimate of $400 million. Naturally, there are many unknowns we do not know, however, these results could bode very well for Apple's earnings and the value of its shares (as long as other factors such as i-Phone 5 sales are also favorable).
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.