Published on Financial Review 10/10/2018 (Original Article Here) – Romano Sala Tenna (Katana Asset Management – an Australian Fund Manager)
A near double-digit drop in the Australian dollar this year has investors positioning to capture an expected earnings tailwind for firms exposed to offshore markets while keeping a cautious eye on importers.
The Australian dollar is hovering around a two-and-a-half-year low, at just above US71¢, after dropping 8.8 per cent this year. The currency has fallen in tandem with a strengthening US economy and rising worries about trade wars.
Morgan Stanley’s Australian equity strategy team commented this week that the Australian dollar in spot terms now appears to be trading below where consensus forecasts have pegged the currency for the first half of 2019.
The Morgan Stanley strategists commented that the ASX200 has a meaningful portion of companies with revenue streams from the US, Asia and Europe.
These firms sit within the industrials-ex financials segment of the stockmarket and account for around 37 per cent of that segment and Morgan Stanley are recommending an overweight exposure to this segment of “global growers”.
“While the trade has worked since 2013, we see an extension of this performance into 2019 as spot Australian dollar now appears to be below what is embedded in consensus forecasts – generating earnings/valuation tailwinds for first-half 2019,” the strategists said.
Export Focus
In their own model portfolio, they have added Aristocrat Leisure, Nearmap and Resmed while exiting Ansell, Nufarm and InvoCare and cutting cash holdings to 3 per cent from 4 per cent to fund their new growth positions.
As the Australian dollar weakens “anything that is export focused is likely to benefit,” Katana Asset Management’s Romano Sala Tenna said, pointing to companies such as A2 Milk and Synlait that supply dairy products to overseas markets, in particular China.
Other firms that are offshore earners and then convert back into local currency that could also gain from a weaker currency include Amcor, Brambles, CSL, Macquarie as well as the commodity names, he noted.
The benefits of a lower Australian dollar are clear in the resource sector where companies are exporting products produced in Australian dollars which are then sold in US dollars. “The [resources] sector is getting cracking prices,” he said.
The sector gets a “double tailwind” from currency in a lower Australian dollar environment, according to Mr Sala Tenna. “If iron ore is at $US68 a tonne, that translates to around $98 a tonne in Australian dollar terms.”
Mixed Picture
As Morgan Stanley pointed out, some of the “global growth” companies that benefit from a currency tailwind have been popular choices for investors for some time. Share prices for some of those offshore earners, such as CSL and Macquarie, have reached record highs this year although they are now trading off their highest levels.
“Investors aren’t rushing into growth companies because they are expensive,” said Jun Bei Liu, portfolio manager at Tribeca Investment Partners. “At the moment, the picture is a bit mixed.”
Rising US bond yields are another factor that could depress share prices for some growth firms given the connection between rising yields and valuation methodology, she believes.
“Bond yields can be used for [discounted cash flow] rates to determine valuations to assess growth companies. It’s too hard to use a price-to-earnings ratio for these firms,” she said. “That’s sensitive to the moves in bond yields.”
On the other side of the equation, a weaker Australian dollar doesn’t tend to be good news for companies that import a lot of products, such as retailers.
While companies can hedge against currency exposure and in some instances can pass on increased costs to their customers “anyone who imports materials is going to get hit,” Mr Sala Tenna said.