Risk Management

Out for the Count

The reaction of Europe's auto manufacturers to the sinking dollar provides an object lesson for other sectors.
Ben McLannahan and Poul Funder LarsenFebruary 17, 2004

These are turbulent times on global currency markets, with the euro hitting a string of all-time highs against the dollar. Worth around 80 cents two years ago, the euro rose from $1.14 last October to more than $1.28 in early January. And it’s expected to continue to rise—some forecasters predict the euro could reach $1.35 this year.

For many finance chiefs in European export industries, the dollar’s slide is exacting a heavy toll. Nowhere is this more evident than in the car industry, given that many European auto manufacturers pay for parts and labour in euros and rely heavily on the US market for sales. Their reaction to the sinking dollar provides an object lesson for other sectors.

Consider Volkswagen: in late January, Merrill Lynch cut its rating on the German auto giant’s stock to sell, citing the firm’s exposure to currency risks and, more particularly, the weak US dollar. PSA Peugeot-Citroën of France has been similarly clobbered. In October, CFO Yann Delabrière said the firm was expecting full-year losses of around €600m because of the strong euro.

That’s put hedging strategies in the spotlight. Volkswagen—which saw €1.2 billion lopped off its pretax profits in the first nine months of last year, thanks to currency swings it hadn’t hedged against—stepped up its hedging last autumn, to around 66% of its dollar exposure from 20% before. Munich-based rival BMW has hedged two-thirds of its exposure for this year and one-third for 2005. Ultra-conservative Porsche in Stuttgart, meanwhile, has hedged all its exposure to the dollar until July 2007.

Changing Gear

With the dollar tipped for further falls in the coming months, Graeme Maxton, an auto industry analyst based in Salzburg, Austria, says most exporters “will be reassessing their ratio of hedging, over which duration, and assessing whether the dollar will fall further and whether it’s prudent to move from their current position.”

Officials at large forex dealing banks say a fresh wave of hedging activity in the auto industry is possible if the euro breaks through the $1.30 to $1.32 zone.

For some car players, fussing over hedging strategies hasn’t always been high on their list of priorities. “German car makers have traditionally said, ‘We’re in the car business, not the currency business,’” notes Ferdinand Dudenhöffer, director of B&D Forecast, an automotive consultancy based in Bochum, Germany. And that explains why firms with US operations are focusing on natural hedging, offsetting the risks of unfavourable exchange rates by matching revenues and costs for the same currency. Mercedes-Benz, for example, is doubling production at its Tuscaloosa, Alabama plant, while BMW is considering expanding output at its plant in Spartanburg, South Carolina.

Henrik Lier, an automotive analyst at WestLB Equity Markets in Dusseldorf, says that the recent turmoil should serve as “a reminder” to all managers that over the long term, this kind of natural hedging is the most effective way of protecting revenue streams. Balancing out supply and demand over currency regions is a simple concept, he says, but it’s a lesson that’s “easily forgotten.”

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