When you hear "Foreign Currency Translations" you may want to buy a Rosetta Stone product to help you with the translation. But you do not have to. Put simply, Foreign Currency Translations is unhedged currency risk and can be found in Alere’s (NYSE:ALR) "Other Comprehensive Income." Historically, the company has benefited from a weak U.S. Dollar and strong Euro. Recently, the U.S. Dollar has strengthened while the weak euro is in the headlines. Currency volatility will be the story for 2012 and it will begin to hit net revenue of companies who do not hedge. The Euro in the fourth quarter 2011 has traded as high 1.41 on October 28 and as low, currently, at 1.30 against the Dollar, a 9% range on a currency that was 18% of Alere's revenue in 2010.
Let me provide a brief introduction to Alere Inc. for those who have not heard of them before this article.
Alere is headquartered in Waltham, Mass., and is a global leader in near-patient diagnostics and related patient management services, with annual revenues in excess of $2 billion and a market cap of about the same. Alere connects individuals and healthcare professionals with the information and resources needed to empower smart health choices, and positively impact health worldwide. They have five strategic business units, Cardiology, Infectious Disease, Women’s & Children’s Health, Drugs of Abuse and Oncology. The company has a presence that spans over 25 countries. During 2010, North America accounted for 65% of revenues; Europe, 18%; and Asia, 11%; with the rest of the world at 6%.
Back to Other Comprehensive Income and Its Foreign Currency Translation Risk
In Alere’s risk factors, they indicate that they generate a significant percentage of their net revenue from outside the U.S., and a significant number of their employees, including manufacturing, sales, support and research and development personnel, are located in foreign countries, including Australia, China, England, Germany, India, Israel, Japan and South Korea. Conducting business outside the U.S. subjects the company to numerous risks.
This was on the mind of CEO Ron Zwanziger as his first sentence in the third quarter 2011 conference call was “I am pleased to report a strong third quarter highlighted by currency adjusted organic growth in our diagnostics business of 8.7%."
FASB 52 provides a brief example of foreign currency translations and its effects on net income:
Translation adjustments are an inherent result of the process of translating a foreign entity's financial statements from the functional currency to U.S. dollars. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place.
Transaction gains and losses are a result of the effect of exchange rate changes on transactions denominated in currencies other than the functional currency (for example, a U.S. company may borrow Swiss francs or a French subsidiary may have a receivable denominated in kroner from a Danish customer). Gains and losses on those foreign currency transactions are generally included in determining net income for the period in which exchange rates change unless the transaction hedges a foreign currency commitment or a net investment in a foreign entity. Intercompany transactions of a long-term investment nature are considered part of a parent's net investment and hence do not give rise to gains or losses.
You may believe the dollar gets stronger against the euro in 2012 as I do and others have forecast. For example, in an December 20 TV interview on Bloomberg, Gary Shilling says the euro is possibly heading to parity with the dollar, but he sees a stop at 1.20 in the near term. 1.20 would be nearly a 10% decline from todays rate. So let's see what would happen to OCI adjustment if this occured.
According to Alere’s 2010 10-K, if the U.S. dollar had been uniformly stronger by 1%, 5% or 10%, compared to the actual average exchange rates used to translate the financial results of our foreign subsidiaries, our net product sales and net income would have been impacted by approximately the following amounts (in thousands):
Approximate (Decrease) in Net Revenue & Approximate Increase in Net Income
If, during 2010, the U.S. dollar was stronger by:
1% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (6,050) $ 32
5% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(30,251) $162
10% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(60,502) $323
Assuming a 10% strength in the U.S. dollar, trailing-12 months EBITDA ending Sept. 30, 2011, would have declined by 13% based on the Capital IQ's calculated TTM EBITDA of $470.76 million. EBITDA is calculated by Capital IQ using methodology that may differ from that used by Alere in its reporting.
1Q 2012 revenue estimates would be hit by:
Mean Estimate: USD 636M by 9.5%
High Estimate: USD 678M by 8.8%
Low Estimate: USD 595M by 10%
Is this risk acceptable in your portfolio?
To summarize, 2012 will be a year of greater currency volatility (fourth-quarter 2011 was just a preview with a 9% peak-to-trough of the Euro against the U.S. Dollar). As an investor, you should be aware of what currency risk lies in each investment you plan to hold in 2012. Aleres' net revenues are vulnerable to currency swings which will be more pronounced in 2012. I believe this currency risk is not reflected in the current stock price. I currently do not own any position in ALR but may do so after the article is published. This stock may be a better short than the euro in 2012.
About the author:
• Realized average annualized returns on self managed IRA account of 14% from January 2004 to December 2012 (total return 150+).
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