So far, the European sovereign debt crisis has had only minimal impacts on the U.S. stock market. Even though stocks had their worst month of the year in May, they're still hanging on to a gain so far in 2012, and the first-quarter earnings season went extremely well, with about two-thirds of the companies in the S&P 500 reporting better-than-expected earnings per share.
All that could change, however, when the current quarter ends in June. One big reason for that is the impact that the European crisis is having on the value of the euro. For companies that get a lot of their revenue in euros, strength in the U.S. dollar will pose big challenges for companies seeking to produce sales growth in the second quarter.
What's down with the euro
Right now, the eurozone is a tale of two regions. In the northern part of the continent, relatively strong fiscal positions make citizens of Germany and other well-off nations extremely reluctant to provide financial support to what they see as their more spendthrift and less disciplined neighbors to the south. Yet for Greece, Italy, Spain, and other countries with weaker economies, the idea of imposing harsh austerity measures in an already struggling economic environment seems doomed to failure and prone to create social unrest.
All this uncertainty has led to a number of possibilities. On one hand, many have long called for Greece to exit the euro and readopt its former local currency, the drachma. Yet some have looked to the flip side of the equation and suggested that Germany should be the one to withdraw from the euro, readopting the deutschemark and allowing it to appreciate against the euro, removing some of Germany's competitive advantages against its European peers.
The net effect of the crisis has been to send the euro plunging against the dollar, falling to two-year lows. That's been good for investors using ProShares UltraShort Euro (NYSE: EUO ) as a play on a stronger dollar. But as much as a weak euro reflects bad news for Europe, it also spells trouble for U.S. companies that do business there.
The European connection
A global economy means that the world's largest companies get paid in a wide variety of foreign currencies wherever they do business. Part of the balancing act that multinationals have to do is to translate their foreign revenue back into their home currency in order to measure their earnings success.
For U.S. companies, when the dollar is weak, earnings get a boost, because their overseas profits become worth more in dollar terms. But a strong dollar has the opposite effect, pressuring net income because foreign earnings are worth less when translated back into U.S. dollars.
With weakness centered on the euro, companies doing a lot of business in Europe are at greatest risk. Among them are the following:
- Philip Morris International (NYSE: PM ) is a U.S.-based company, but it does all its business overseas. Almost two-thirds of its revenue comes from Europe, and although not all of those sources have the euro, Philip Morris will nevertheless take a big currency-related hit if the dollar stays strong throughout the second quarter.
- McDonald's (NYSE: MCD ) has restaurants around the world, but Europe is a pretty big piece of its pie, with roughly 40% of revenue coming from operations on the Continent.
- Ford (NYSE: F ) has about 30% of its sales coming from Europe. Even with the relative strength of the U.S. auto industry, Europe has proven to be a problem area for Ford for some time, and weakness in the currency to go along with poor sales there could be a tough double whammy for the automaker to swallow.
- Electronic Arts (Nasdaq: EA ) gets almost as much revenue from Europe as it does from North America, weighing in at more than 45% over the past 12 months. With European sales having grown at a faster pace than North American revenue in recent years, the crisis comes at a particularly unfortunate time for EA.
Obviously, foreign exchange fluctuations play only a part of any company's overall earnings picture. But Europe's economic weakness is already a drag on companies that do a lot of business there, and so currency headwinds on top of that weakness just add insult to injury.
With only a month left in the second quarter, it would take a huge rebound in the euro to offset the currency's weakness we've already seen. In all likelihood, U.S. investors in these and other companies that do a lot of business in Europe should start bracing for the impact a weak euro will have on this quarter's earnings.
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