A Stronger Dollar Remains a Risk

The strengthening of the dollar has been a constant threat to companies with international market exposure, as it lowers net sales and earnings after the conversion and consolidation of financial statements in dollar terms throughout different regions/segments. Three companies with significant international market exposure that render them vulnerable to currency headwinds are Coca-Cola Company  (NYSE: KO  ) , Mondelez International (NASDAQ: MDLZ  )  and Colgate-Palmolive (NYSE: CL  ) .

Strengthening of the dollar remains a pain
Coca-Cola has a dominant position in the global beverage industry. The company conducts its business in more than 200 countries and has more than 3,500 products. More than 50% of the company's total revenue is earned from markets other than North America, which exposes the company to foreign currency risk. In fiscal year 2012, the company used 81 functional currencies for financial performance/record purposes. As a result of the dollar strengthening, the company's operating income for 2012 decreased by 5%. The Brazilian Real and the South Africa Rand were the currencies that weakened the most against the dollar last year, by 14% and 12%, respectively. The trend of the dollar strengthening continued in 2Q 2013, which had an adverse impact of 2% on Coke's total revenues.

Coca-Cola has been aggressive in its efforts to expand its operations in emerging markets, especially in China and other neighboring countries, to tap the growth opportunities available in the region. The growing international market exposure will further eat up revenue growth for Coca-Cola due to the aforementioned strengthening of the dollar. The company's management expects that currency movements will have a negative impact of 4% on total revenues in 2013.

The snacking powerhouse, Mondelez International, is another dominant performer in the snack food industry. Mondelez generates approximately 80% of its total revenue from markets other than the U.S., with 44% coming from emerging markets. The exposure to emerging markets is the primary stock price catalyst for Mondelez, as it offers impressive growth opportunities.

Consistent with its plans for international expansion, Mondelez recently broke ground to expand its capacity and operations in China. Also, the company has been undertaking strategic acquisitions to further strengthen its market share and position worldwide. As Mondelez's international business continues to grow, foreign currency risk will deepen for the company. In the second quarter of 2013, approximately 2% of total revenue decreased due to currency movements. It is also projected that the company will lose almost 3% of its total revenues due to foreign currency movements in 2013. 

Another important stock price catalyst for Mondelez is the opportunity to grow earnings through expansion in operating margin over time. The company can expand its operating margin by 250 bps to 300 bps by 2017. Mondelez has the potential to expand its operating margin in its European operations by reducing excess overhead costs. Also, Mondelez is consolidating its U.S. and Canadian headquarters to improve its cost structure. Moreover, as the company grows its operation in emerging markets, its operating margin will improve due to better leveraging of its fixed cost. Currently, Mondelez's gross and operating margins are below as compared to its industry average. The following table shows the margins comparison between Mondelez and its peers.

 

Mondelez International

Kellogg Company

The Hershey Company

General Mills

Average

Gross Margin

37%

38%

45%

37%

39%

Operating Margin

12%

15%

19%

16%

15.5%

Source: Annual Reports

As a leading consumer products company, Colgate-Palmolive serves people in more than 200 countries. Given the large global footprint, more than three quarters of total revenues for Colgate-Palmolive are earned from international markets. The significant international market exposure is an important growth driver for Colgate-Palmolive; however, it also eats away a notable portion of total revenue growth due to foreign currency movements. In the second quarter, 3% of total revenues were erased due to foreign currency exposure. Colgate-Palmolive has been aiming to expand its international business, specifically targeting emerging markets to achieve growth. Other than international market expansion, Colgate-Palmolive has been pushing margin expansion to grow its EPS. In 2Q 2013, Colgate-Palmolive was able to expand its operating profit by 3%.

A favorable geographical footprint and higher emerging markets' margins in comparison to developed markets makes Colgate-Palmolive superior to its peers. Due to significant emerging market exposure and high growth prospects, Colgate-Palmolive trades at premium valuations compared to the broad market. Colgate-Palmolive has a forward P/E of 19x in comparison to the S&P's forward P/E of 15x. Also, the company has higher operating margins in contrast to its peers, which can be used to reinvest and achieve growth and increase its market share. The following table displays the operating margin comparison between Colgate-Palmolive and its peers.

 

Colgate-Palmolive

Procter & Gamble

Unilever

Operating Margin

24%

18%

14%

Source: Yahoo! Finance 

Final words

Significant emerging market exposure is considered to be an advantage for consumer companies; however, the companies also have to face currency headwinds because of it. Hence, foreign exchange translation remains a risk for the above-mentioned companies, as large chunks of sales are coming from outside U.S. markets, negatively impacting the companies' sales and earnings growth. 

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