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With the US dollar resurgent on the back of the rising tide in the US 10-year bond yield – which recently surpassed 3% for the first time in four years – other currencies, including the Australian dollar, are sliding in its wake.
After a 15-month fall, during which it surrendered 14%, the US dollar index, which measures the greenback against a basket of other currencies, has added 4.4% since the start of February. In “our” cross – the A$/US$ rate – the Aussie has dropped more than six “big figures” (or US cents), from 81.06 US cents, to the current quote of 75 US cents.
And with the US economy well and truly in “goldilocks” territory – not too hot, not too cold – and US yields heading higher, with further official interest rate rises almost certainly coming from the Federal Reserve this year, the greenback looks to be only getting started. This kind of rally can become self-fuelling, as big speculative “short” positions on the US dollar are unwound.
In this kind of environment, it would be very easy for the Australian dollar to fall further.
That is good news for the Australian companies that earn revenue in the US dollar, which will be boosted, in A$ terms, by the weaker A$. Each ‘unit’ of US dollar-denominated revenue buys more Australian dollars when it’s converted to the weaker local currency in the reported financial results. However, many of the companies run hedging programs to try to smooth-out currency effects, and in some cases, may not gain the benefit that the current exchange rate might imply that they should. (In some cases, too, they might do a bit better.)
A weaker A$ is also good news for shareholders in the Australian companies that actually report their results in US dollars: any change in the exchange rate will directly impact their results. The twice-yearly dividend payments will be higher when converted to A$, depending on the exchange rate at the time the dividend hits their bank accounts. These stocks should also show a benefit in the share price when the A$ is weak.
In the group of companies that report their financial results in US$ are the big miners and petroleum heavyweights – BHP, Rio Tinto, Fortescue Metals, Newcrest Mining, South32, Woodside Petroleum, Oil Search and Santos – as well as major industrials with global operations, such as CSL, Amcor, Westfield, QBE Insurance, Brambles, Computershare, Janus Henderson Group, James Hardie and ResMed.
Any fall in the A$ against the US$ would also benefit companies with significant percentages of their revenue coming from the US, such as Boral, Treasury Wine Estates, Macquarie Group, CSR, BlueScope Steel, Austal, Cochlear, Flight Centre, SDI, Carsales.com.au, Aristocrat Leisure, Ainsworth Gaming Technology, Hansen Technology, News Corporation, Twenty-First Century Fox, Seek, Sims Metal Management, Orora, IPH, Mayne Pharma, Sonic Healthcare, GrainCorp, Integrated Research, SomnoMed, Ansell, Breville, Adelaide Brighton, GWA, SDI, Navitas, Bega Cheese, Incitec Pivot, Ardent Leisure, Altium, Transurban, Nufarm and Orica.
The caveat is, however, that all that matters in the long run is a healthy business, with growing market share and increasing earnings over time. It does not do these companies’ shareholders much good if there are issues with the underlying business, at the same time as they are theoretically benefiting from a lower A$. If the company’s business is struggling, the earnings benefit of a lower home currency will not be worth much. For example, Ainsworth Gaming Technology is one of our top overseas earners – it generates three-quarters of its revenue overseas, up from one-third just six years ago – but a disappointing trading update released last week saw its share price hammered by almost 40%. Traders dumping the stock were not even thinking about the boosted conversion effect on Ainsworth Gaming Technology’s US-dollar revenue and earnings.
It is good to have these overseas-sourced cash flows: for Australian investors, the argument for international diversification is very strong, even with the strong home bias that the dividend franking system guarantees. If you own the big biotech heavyweights, for example – CSL, Cochlear and ResMed – you own companies with global exposure that are tapping into the health needs of the ageing population in developed nations, while at the same time, picking up on the growing wealth of rapidly developing nations with burgeoning middle classes.
Similarly, the big resources companies such as BHP, Rio Tinto, Fortescue Metals and Woodside Petroleum are exposed to the world economy, and particularly, the growth of the Chinese economy. Fortescue is in a slightly different position to the others, as its cost base is almost wholly denominated in the Australian currency – thus, it benefits more from a falling A$.
The most direct benefit from a falling A$ is the BetaShares US Dollar ETF (ASX code: USD), which is designed to track the performance of the US dollar relative to the Australian dollar (before fees and expenses). For example, if the US$ dollar gains 10% against the A$, the US Dollar ETF is designed to go up 10% too, before fees and expenses.
That suits a short-trading view, but investors taking a longer-term view on currency weakness should be looking to buy and hold some of the Australian market’s most globally diversified stocks, that generate earnings around the globe.
The problem here is that, in many cases, the trade-off is low levels of franking, reducing the attractiveness (at present) of these stocks to income-oriented investors. However, the global exposure should be more of a driver of the investment decision.
On a long-term basis, global-oriented stocks such as CSL and Sonic Healthcare are very consistent and well-managed companies – but temporarily, these appear close to being fully valued, on analysts’ consensus target price grounds.
CSL (CSL, $170.94)
FY19 yield: 1.3%, unfranked
Analysts’ consensus target price: $172.20
Sonic Healthcare (SHL, $23.78)
FY19 yield: 3.6%, 20% franked
Analysts’ consensus target price: $24.50
My pick for where there appears good value at present is the following group of five large foreign-currency earners (and some US$ reporters):
Rio Tinto (RIO, $80.94)
FY19 yield: 4.7%, fully franked
Analysts’ consensus target price: $88.40
Fortescue Metals (FMG, $4.83)
FY19 yield: 5.5%, fully franked
Analysts’ consensus target price: $5.22
Incitec Pivot (IPL, $3.77)
FY19 yield: 3.2% unfranked
Analysts’ consensus target price: $4.61
Aristocrat Leisure (ALL, $27.39)
FY19 yield: 2.1%, 69.12% franked
Analysts’ consensus target price: $30.21
Westfield Group (WFD, $9.07)
FY19 yield: 3.3% unfranked
Analysts’ consensus target price: $9.97