Last year I published an article stating that 2012 would be a year of greater currency volatility. The euro did continue to fall during the year with FXE falling to a low of 119 in late July 2012. I examined Alere Inc. (ALR, Financial), which had 20% of its revenues in euros, as an example of a company whose currency risk was not reflected in the share price. By the second quarter of 2012, Seth Klarman of The Baupost Group sold his entire position in Alere.
Currency volatility continues as it has most recently appeared in the Japanese yen. The yen FXY was at 126 in October and now is at 111, a 12% decline. There have been many articles written about who benefits from a weaker yen, so I decided to look at some companies that would be hurt by a weaker yen. As an investor, you should be aware of what currency risk lies in each investment you plan to hold.
Coach (COH, Financial) and Ralph Lauren (RL, Financial) are two retailers with exposure to a weak Japanese yen.
Coach hedges its currency risk in inter-company loans and inventory purchases, but not revenue:
"Coach believes that exposure to adverse changes in exchange rates associated with revenues and expenses of foreign operations, which are denominated in Japanese yen, Chinese renminbi, Hong Kong dollar, Macanese pataca, Canadian dollar, Singapore dollar, Taiwan dollar, Malaysian ringgit, Korean won and the Euro, are not material to the Company’s consolidated financial statements (source 10-K 2012)."
Ralph Lauren hedges its currency risk in inventory purchases, inter-company transactions, interest and debt payments an operational cash flows, but not revenue:
“Local currency revenues and expenses are translated at average rates of exchange effective during the period (source 10-K 2012)."
Does this mean the companies are fully hedged from a three-month, 12% decline in the Japanese yen?
Hedges are typically zero cost, meaning they sell options to buy option of opposite sides (put and calls) which makes it no initial cost to the company. The company hedges cover risk in the currency of say 3% to 5%. Outside of that range the company can have a significant loss.
Below are Coach‘s latest 10-K comments on hedges and currency risk:
“We cannot ensure, however, that these hedges will fully offset the impact of foreign currency rate movements. Additionally, our international subsidiaries primarily use local currencies as the functional currency and translate their financial results from the local currency to U.S. dollars. If the U.S. dollar strengthens against these subsidiaries’ foreign currencies, the translation of their foreign currency denominated transactions may decrease consolidated net sales and profitability.”
Ralph Lauren's 10-K states:
“Although we hedge certain exposures to changes in foreign currency exchange rates arising in the ordinary course of business, we cannot fully anticipate all of our currency exposures and therefore foreign currency fluctuations may have a material adverse impact on our financial condition and results of operations. In addition, factors that could impact the effectiveness of our hedging activities include the volatility of currency markets, the accuracy of forecasted transactions and the availability of hedging instruments. As such, our hedging activities may not completely mitigate the impact of foreign currency fluctuations on our results of operations.
Both companies state that their hedges may not be effective. The volatility of the Japanese yen from OCT to DEC will certainly reduce the effectiveness on each company’s hedge program.
What to expect from revenue in yen?
Both companies use a weighted average of the currency rate in the quarter to use for revenues. This will slightly overstate revenue in yen as retail sales are the strongest in November and December when the yen was down significantly.
Expect earnings to be affected by the 12% weaker yen for both companies and in addition, look for hedging losses to show up in the next earning release. Earnings for Ralph Lauren are expected to be released on Feb. 8, 2013, while Coach is expected to release its earning Jan. 28, 2013.
Currency volatility continues as it has most recently appeared in the Japanese yen. The yen FXY was at 126 in October and now is at 111, a 12% decline. There have been many articles written about who benefits from a weaker yen, so I decided to look at some companies that would be hurt by a weaker yen. As an investor, you should be aware of what currency risk lies in each investment you plan to hold.
Coach (COH, Financial) and Ralph Lauren (RL, Financial) are two retailers with exposure to a weak Japanese yen.
Coach hedges its currency risk in inter-company loans and inventory purchases, but not revenue:
"Coach believes that exposure to adverse changes in exchange rates associated with revenues and expenses of foreign operations, which are denominated in Japanese yen, Chinese renminbi, Hong Kong dollar, Macanese pataca, Canadian dollar, Singapore dollar, Taiwan dollar, Malaysian ringgit, Korean won and the Euro, are not material to the Company’s consolidated financial statements (source 10-K 2012)."
Ralph Lauren hedges its currency risk in inventory purchases, inter-company transactions, interest and debt payments an operational cash flows, but not revenue:
“Local currency revenues and expenses are translated at average rates of exchange effective during the period (source 10-K 2012)."
Does this mean the companies are fully hedged from a three-month, 12% decline in the Japanese yen?
Hedges are typically zero cost, meaning they sell options to buy option of opposite sides (put and calls) which makes it no initial cost to the company. The company hedges cover risk in the currency of say 3% to 5%. Outside of that range the company can have a significant loss.
Below are Coach‘s latest 10-K comments on hedges and currency risk:
“We cannot ensure, however, that these hedges will fully offset the impact of foreign currency rate movements. Additionally, our international subsidiaries primarily use local currencies as the functional currency and translate their financial results from the local currency to U.S. dollars. If the U.S. dollar strengthens against these subsidiaries’ foreign currencies, the translation of their foreign currency denominated transactions may decrease consolidated net sales and profitability.”
Ralph Lauren's 10-K states:
“Although we hedge certain exposures to changes in foreign currency exchange rates arising in the ordinary course of business, we cannot fully anticipate all of our currency exposures and therefore foreign currency fluctuations may have a material adverse impact on our financial condition and results of operations. In addition, factors that could impact the effectiveness of our hedging activities include the volatility of currency markets, the accuracy of forecasted transactions and the availability of hedging instruments. As such, our hedging activities may not completely mitigate the impact of foreign currency fluctuations on our results of operations.
Both companies state that their hedges may not be effective. The volatility of the Japanese yen from OCT to DEC will certainly reduce the effectiveness on each company’s hedge program.
What to expect from revenue in yen?
Both companies use a weighted average of the currency rate in the quarter to use for revenues. This will slightly overstate revenue in yen as retail sales are the strongest in November and December when the yen was down significantly.
Expect earnings to be affected by the 12% weaker yen for both companies and in addition, look for hedging losses to show up in the next earning release. Earnings for Ralph Lauren are expected to be released on Feb. 8, 2013, while Coach is expected to release its earning Jan. 28, 2013.
