Dollar Up, Costs Down?

The strong dollar is not so sad an occurrence for Corporate America as many presume. Image by Image Source/Getty Images.

(Editor's Note: Fisher Investments' MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

After the close Wednesday, US aluminum firm Alcoa reported earnings in what some oddly consider^[i] the opening of Q1 2015's earnings season. Thursday, Constellation Brands-a large brewer and distiller (think Corona, Modelo and more) reported earnings. Both firms' results and commentary from executives on conference calls tell an interesting tale about one specific concern many folks fear will quash US stocks: the strong US dollar. You see, the rising dollar crushed neither of these multinationals, and both illustrate the stronger dollar's mixed impact on firms' fundamentals.

Measured against a broad trade-weighted basket of currencies, the dollar has risen 14.3% since June 30 last year.^[ii] Exhibit 1 is a picture of that.

Exhibit 1: Trade-Weighted US Dollar Index (Broad Definition)

Source: Factset, as of 04/09/2015. 12/31/2013 - 03/31/2015.

The up move has fueled fears the strong dollar will make US exports uncompetitive abroad, weighing on large US multinationals' overseas sales and crushing earnings. Most come to one of two conclusions: The strong dollar will end the bull market, or it will cause US stocks to stop outperforming the world.

But Alcoa and Constellation tell a much less one-sided story. For the record, both firms' earnings grew and topped estimates. Both firms' revenues grew but missed.^[iii] But that's not why you come here, and you could probably read that "analysis" anywhere. More interesting to us were comments made on the conference calls.

For months, big firms' executives have cited the rising dollar as a potential headwind, perhaps one reason for the many news stories surrounding this fear. Now, these assertions could be true in some cases, or gamesmanship to massage analysts' estimates in others. But the conference calls showed it isn't merely a unilateral negative. According to Alcoa CFO William F. Oplinger, the strong dollar contributed by lowering the business's costs. Oplinger said, "(Alcoa's) Cost of goods sold percentage decreased by 160 basis points sequentially, primarily driven by the strong US dollar and productivity, partially offset by lower LME (London Metals Exchange) pricing." The boldface is ours.^[iv] Constellation's reference to the same was less overt. On the conference call, an analyst asked CFO Bob Ryder for his take on the impact of the dollar on the brewer and distiller. Ryder's response caught our eye:

Most of - as you say Tim, most of the machinery equipment are dollar based, actually most of the commodities and production are dollar based. But the big local cost of course is Mexican labor. So Mexican labor being used on the construction, will end up on the balance sheet, right and that will come down in price. So that will be good.^[v]

Ryder went on to note this isn't a huge benefit to Constellation, but taking Alcoa's and Constellation's commentary in concert highlights a simple-yet-often-overlooked point: US multinationals have revenues and costs overseas. So while a strong dollar may slow some firms' revenue growth, many like Alcoa and Constellation will simultaneously benefit from the rising dollar lowering their costs. We would also suggest many non-Energy sector firms will enjoy some benefit from falling oil prices, too, though it doesn't seem to have helped these two.

This is one fundamental reason why a strong dollar isn't automatically negative for large US multinationals' performance. It isn't automatically negative for their fundamentals, so why would it be? What's more, the dollar's moves have been widely discussed for at least two quarters. All sufficiently liquid markets discount widely known information nearly immediately. The strong dollar isn't sneaking up on anyone, just as it didn't in the mid-to-late 1990s, when large US stocks performed very well indeed.

Earnings season has a long way to go, and we doubt you've heard the last of strong dollar fears. Some companies will see a negative impact from the stronger dollar. We'd simply suggest this is far from the complete story, which is likely to prove much more mixed.