Why a stronger dollar hurts corporate earnings

NEW YORK - The biggest obstacle for Coca-Cola and Pepsi these days isn't tied to taste tests, the declining popularity of sugary drinks or even their century-long rivalry. It's the surging U.S. dollar.

The two soda giants rely on overseas customers for roughly half of their revenue. When they turned in their quarterly results last week, both reported a drop in sales. The strong dollar made all the difference: strip it out and shrinking sales suddenly rise.

The dollar has been a source of constant complaint this earnings season. Global corporations from Avon Products to Yum Brands have said their quarterly results would have been much better if it hadn't been for the rising dollar. For some, the currency's strength has meant the difference between a profit and a loss.

"It has really hit earnings," said Jack Ablin, chief investment officer at BMO Private Bank.

Over the past year, the dollar has climbed 18 percent against major currencies. The surging dollar and plunging oil prices are the main reasons analysts keep cutting their forecasts for corporate profits even though economists expect the U.S. economy to pick up speed

Back in October, analysts estimated that companies in the Standard & Poor's 500 index would post profit growth of 11 percent for the final three months of 2014. That forecast now looks overly optimistic. With only a handful of companies left to report, corporate profits are on track to rise more than 7 percent, according to S&P Capital IQ.

Forecasts for this year have taken a much bigger hit. In December, for example, analysts projected that profits would increase 9 percent in the first quarter. Today, they expect them to shrink more than 2 percent over that same period.

A strong U.S. dollar might seem like a badge of honor, a reflection of U.S. economic power in the global economy, but for much of Corporate America, it's bad for business. Almost half of all revenue for companies in the S&P 500 comes from outside the United States, mainly Europe and Asia. So when the dollar rises against the euro, it hurts in two ways: Prices of American-made goods become more expensive to customers in Europe, and goods that move off foreign shelves translate into fewer dollars, showing up as lower revenues and earnings on quarterly financial reports.

Take Avon Products, a company that depends on customers in Latin America for nearly half of its sales. Last week, the cosmetics company reported that its revenue fell 12 percent and adjusted earnings sank 41 percent. Erase the dollar's move against foreign currencies and the picture looks entirely different. Revenue would have climbed 5 percent, and adjusted earnings would have soared 29 percent.

At Procter & Gamble, revenue fell 4 percent in the quarter but would have increased 2 percent if the dollar had stayed put. And the maker of Tide detergent and Pampers diapers doesn't think the drag from the dollar is over yet. It estimates that the currency's rise will shave $1.4 billion from its profit over the course of the full year.

"This is the most significant fiscal year currency impact we have ever incurred," said P&G's chief financial officer, Jon Moeller, in a conference call discussing the latest results.

The list of companies complaining of currency swings includes nearly every major industry. Microsoft, Google and other tech giants have taken a hit along with Bristol Myers Squibb, Pfizer and other drugmakers. Even Apple, which turned in a record profit of $18 billion in its latest quarter, said the rising dollar cost the company $2 billion in sales. Electric-car maker Tesla, the hotel chain Hilton, and the navigation device maker Garmin have joined the ranks of the dollar debilitated. On Thursday, Wal-Mart slashed its sales forecast for the rest of the year in half, largely because of the dollar.

"A lot of the companies I follow have cut their earnings guidance for the year, and it was all a result of FX," said Bill Stone, chief investment strategist at PNC Asset Management, using Wall Street's shorthand for currency moves -- foreign exchange. "It wasn't their underlying business that was the problem. It was just FX."

Overseas sales used to provide a boost to U.S. companies. When the economy floundered during the Great Recession, firms expanded their businesses abroad, harnessing faster growth across Asia and South America.

What once looked like a prudent move, however, has come back to bite them. U.S. economic growth is outpacing Europe and Japan, and growth in China and other emerging giants has cooled off. The result: a rising U.S. currency and falling revenue for U.S companies.

Most analysts on Wall Street believe the dollar will continue gaining against the euro and Japanese yen. Jim Paulsen, chief investment strategist at Wells Capital Management, said those expectations are based on the idea that Europe will continue to struggle. What if Europe's recent efforts to revive its economy work? Paulsen said it could knock the dollar down, easing the burden for big U.S. companies.

Last month, the European Central Bank launched a stimulus effort that sent the euro to record lows against major currencies. That might sound like a bad thing, but it could actually turn things around. The euro's drop means that European goods are cheaper for overseas buyers. That could give a boost to countries with big export industries, such as Germany and Italy, and help pull the region out of its long slump. If that happens, the euro should start recovering, sapping strength from the U.S. dollar.

"Everybody right now seems convinced that the dollar is going to stay strong," Paulsen said. "But I think that a weaker dollar is the story this year. That will be the real surprise."