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Corporations Rush to Hedge U.S. Dollar

Fin - Breakout - US

Wolfgang Koester is on the front lines of corporate America's efforts to lessen our collapsing currency's impact on the bottom line. The CEO of FiREapps helps hedge currency risk for U.S.-domiciled heavyweights such as Nike (NKE) and Accenture (ACN), and he says demand for his services is rocketing as more companies become concerned about a weak greenback.

Why would a company need currency hedging? For one thing, in a multinational world, companies such as Nike and McDonalds (MCD) get a majority of their revenues from countries other than the United States. That means the earnings generated from those foreign revenues, likely the majority of their earnings, need to be calculated and converted into U.S. dollars, both for the sake of financial reporting and in financial reality (at least in theory) if and when the money is brought back to the States. Whether or not these companies hit their plans and estimates is often a function of what happened to the dollar during that period. If you're doing a fantastic job making shoes or burgers, you'd rather not have your quarterly destiny tied to what Ben Bernanke does.

Compared to just two years ago, the U.S. dollar is down more than 20% vs. the Canadian loonie and over 30% against the Aussie dollar, to name just two of the many countries in which your buying power has collapsed. That said, dollar neglect typically leads to higher corporate earnings, unless it weakens the buying power of U.S.-based companies going to foreign lands to buy raw materials. In this case, an offset needs to be created for a one-time charge statement.

Let's just say plenty of organizations are looking to get rid of the currency headache by outsourcing it to guys like Koester. The questions for investors are: Which companies are doing their hedging well, does this lead to higher stock prices and what does the hedging say about the direction of the dollar going forward? Not shockingly, Koester says his clients are doing well in terms of hedging, citing Agilent (A) and Google (GOOG) as two examples. On the other hand, he says Alcoa (AA) in particular is an apathetic hedger, leading to unpredictable earnings. Off camera he also mentions Phillip Morris International (PM), which derives all of its earnings from overseas (after a split from Altria) and hedges not at all. Whether or not it matters to investors is generally a function of the current trend.

Does the market simply "look past" currency impact on quarterly earnings when pricing a stock? From market experience, a company worried about hedging is less focused on actual operations. What's more, just like individual traders, corporations tend to get swept away in frenzied moves from exogenous factors such as dropping dollars and rising input costs. Consider the airline industry's rush into jet fuel hedging near the heights of crude's rise. Those who had experience in the game, like Southwest (LUV), prospered. Those who didn't, like AMR (AMR), took substantial one-time charges. Ultimately, how the stocks performed was more a function of operational execution and the fact that the airline industry is the land that love forgot.

A dollar rally seems wildly implausible in an environment of unprecedented stimulus programs. Of course, the reversal of well-established trends always seems unlikely. If past is prelude, and it generally is, ramping demand for dollar hedging suggests a bottom in the dollar may be at hand. The end of sharp moves always comes when no one expects it. Even if dollar impact is largely not a factor in stock prices, the dollar drop is behind, or at least correlated with, moves higher in gold, crude, silver and nearly any other asset you could buy overseas. Whether we like it or not, most Americans' portfolios are heavily impacted by the dollar.

You don't have to believe or, for that matter, understand a rally in the dollar, but it'll pay off to get in touch with your inner Wolfgang Koester and start thinking of ways to lessen the impact a reversal could have on your portfolio.

Let us know what you think. Write to us at Breakoutcrew@yahoo.com.