It pays to hedge those currency risks
Sunday 10 August 1997
For companies whose raison d'etre is making and selling widgets, it is tough when moves in the currency market threaten to distract attention from their core business. But with shifts in the value of the dollar and the pound this year catching European companies on the hop, investors say they are wary of investing in businesses which do not bulwark profits against changes in the currency market.
"Hedging leaves companies to do what they do best," said Ingrid Burkhardt, a fund manager at Metzler Investment in Frankfurt. "They are not currency speculators."
Hedging allows companies to reduce their exposure to currency movements by locking into a fixed exchange rate for a set period of time, or by buying options that pay out a profit if a currency moves by a set amount.
Austrian textile maker Wolford, which makes 82 per cent of its sales outside Austria, is one European company that has not benefited fully from the dollar's strength. Its hedging strategy meant it missed out on a currency kicker to its 1997 profits,
which grew by 14.6 per cent to Sch190.6m ($15m).
Chief financial officer Karl Millauer reckons the strategy cost Wolford about Sch30m in missed profit.
Nevertheless, Michael Richter, an equity fund manager at Epicon Asset Management in Vienna, who owns Wolford shares, said he prefers to invest in companies that try to minimise their foreign exchange exposure, even if that means they miss out on potential gains. "Generally, it is more of a sign of intelligence when the company hedges their risks," said Mr Richter. "What is negative is when a company pursues an aggressive financial policy with no consideration to the risks."
The mark has lost more than 15 per cent of its value against the dollar this year, falling to an eight-year low of DM1.8905 last week. That should benefit German exporters, making goods cheaper in US markets and boosting the value of overseas earnings.
Daimler makes 60 per cent of its sales abroad. The company missed out on a potential 6 per cent boost to its DM1.85bn (pounds 460m) of first-half operating profit, however, as it stepped up its defences against the danger of foreign-exchange shifts eroding profit.
"I think hedging is absolutely necessary," said Manfred Gentz, Daimler's chief financial officer. "We are hedging quite a lot of positions more than we did before, because you never know when this trend will end."
Volkswagen, burnt 10 years ago when it lost DM470m after finance officials speculating in the currency market got their derivatives bets wrong, also missed out on gaining from the dollar's rise. But it is not about to change its tactics.
Not all companies are convinced of the value of hedging. Schwarz Pharma, a German pharmaceuticals company, said sales in the first-half of 1997 rose 7.6 per cent to DM632.8m. The company said DM24.5m of the DM44.7m sales increase were due to "positive currency effects". "Our major currencies are the dollar, pound and lira, but all these are strong at the moment and are still improving, so we are benefiting from these exchange rates," said Klaus Peter Langer, Schwarz Pharma's chief financial officer.
"You have to look at the other side - what would happen if the currency went the other way," said Ms Burkhardt. She was sceptical of buying shares in companies that don't hedge.
As with any form of insurance, hedging is not free. There is a cost involved in buying currency options, and if the currency market does not move against the hedging company, that is money it could have invested in its business. GKN saw currency moves bite pounds 18m off its first-half pre-tax profits of pounds 203m. Without the fluctuation, GKN's pre-tax profit would have risen by more than twice the 12 per cent it gained.
"We only hedge on aerospace and defence export contracts, which are the only export components of GKN," said chief executive, C K Chow. "Whenever we take an order, we hedge the whole programme ahead. So we protect our entire exchange exposure. We eliminate the risk."
GKN avoids currency exposure on its auto parts business by manufacturing parts in the nation where they are sold. It is building new factories in Poland, China, and Brazil to be able to supply motor manufacturers there. And, even though those overseas earnings can be affected, once they are translated into pounds, Mr Chow said they do not involve a loss of cash, undermining GKN's ability to do business, so he is not going to hedge.
With currency markets likely to remain volatile as the planned 1999 start date for the European single currency approaches, hedging is likely to play a bigger role for European companies.
"The period before the introduction of the euro is a volatile time, and it seems sensible to stick to a fairly conservative hedging policy," said David Rothblum, head of investor relations at Siemens. "You have to remember that two years ago, peoplewho did not hedge got seriously hurt," Mr Rothblum said.
Copyright: IOS & Bloomberg
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