Operational and Financial Hedging With the Weak Dollar

Includes: TEX, TKR
by: The Operations Room

by Gad Allon

The Wall Street Journal had an interesting article on the way different firms handle the weakness of the dollar (“Dollar’s Swoon Opens Doors“). The article outlines the three main ways firms hedge against exchange rate uncertainty:

First, firms may use a natural hedge, by producing and selling within the same market:

We tend to manufacture where we sell our products,” says Glenn Eisenberg, chief financial officer at Timken Co. The Canton, Ohio-based maker of roller bearings, gear boxes and other industrial goods has manufacturing plants in 12 countries. As a result, he said, currency swings “tend not to be a big issue,”

Second, firms may use their global network of plants and products and exploit currency differences (note that Mr DeFeo uses the term natural hedge to something a bit different than our definition) :

A strong dollar tends to help Terex, making it easier to sell machinery it makes in Europe to U.S. customers. But Terex also exports machinery from the U.S. With plants in both places, Mr. DeFeo says, to some extent “we have a natural hedge” against currency swings.

Third, firms may use pure financial hedging via forward contracts:

For instance, the company uses forward contracts, which lock in currency-exchange rates on certain future dates, and it buys parts in a variety of currencies. “We’re fine for now,” Mr. DeFeo says, as currency rates haven’t reached “extremes.”

Here, it is important to note that while financial hedging, like any type of insurance, is expensive, operational hedging (options 1 and 2) can be beneficial and value- creating, if the flexible options are wisely used by the firms. (This is a topic which is discussed in the Operations Strategy class at Kellogg). We also have to remember that the weakening of the dollar carries many advantages for local manufacturers:

For some smaller companies, the dollar’s weakness offers greater potential benefits because they are growing from a small base. Ron Overton, president of Overton Industries Inc., a tool-and-die company in South Mooresville, Ind., recently hired a marketing company in Chicago to help find more buyers in Japan and elsewhere in Asia. With the dollar on the ropes, “We have a little bit of a price advantage,” says Mr. Overton, whose company traditionally has relied on North America for nearly all its sales.

As the article sums it up nicely, in the absence of free-trade agreements, a weaker dollar is one of the few ways you can get growth going.