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Higher relative interest rates, the USD/AUD or JPY/AUD carry trade, stronger commodity prices, and a movement away from ‘safe haven’ into risky assets: These are just some of the reasons for the Aussie dollar’s (AUD) current strength against the greenback (USD). And given how far ahead of the interest rate curve the Reserve Bank’s (RBA) monetary policy is compared to the rest of the world, the AUD will remain the best performing currency for some time to come.

If the tone of the RBA’s underlying commentary is any guide, it’s unlikely to stop raising rates until it reaches neutral levels. And based on the estimates of Kathy Lien at GFT Forex, this will be between 4.25-4.5 percent. As a result, she says the interest rate differential between the AUD and other currencies will continue to grow, hence propelling the AUD even higher.

While Lien doesn’t subscribe to the popular AUD/USD ‘parity prediction’, she expects another 5 to 7 percent rally in the AUD/USD to see the AUD trading at US98.5c six months from now and at US96.5c in one year. So with the AUD expected to remain historically higher for longer, which sectors stand to benefit the most, and which will be hardest hit?

Admittedly, myriad factors, encompassing everything from hedging policies through to accounting anomalies means there’s no ‘magic-bullet’ for picking winners and losers from the ascent of the AUD. But ‘rule-of thumb’ estimates by Damien Klassen currency analyst with Wilson HTM suggest that every 10 percent increase in the AUD will decrease Australian market earnings by 5-7 percent. Conversely, his estimates suggest a 10 percent change downward will have a positive earnings-per-share (EPS) effect of 3-5 percent.

So assuming the AUD trades at an average US95c in 2010, which stocks can investors’ look to for EPS growth and which ones should they potentially avoid? At the sector-specific level, he says resource stocks/exporters and companies with significant international exposure are the most negatively affected by the high AUD.

As a case in point, Billabong (BBG) which derives around 80 percent of its revenue from offshore, expects company profits to drop by $500,000 for every 1c rise in the monthly average value of the AUD against the USD (above 92c). Similarly, Foster’s Group (FGL) warned shareholders that the more the AUD exceeds US90c and 55 pence respectively, the less it can compete in global markets.

Klassen says while domestic resources, with sales primarily determined by USD prices and costs in AUD, are most exposed to currency – a rise in the AUD can also be off-set by a corresponding rise in commodity prices. “For international resources, where sales are determined by USD prices and costs are not in AUD, the effect on EPS is often more muted as falling costs partially offset the falling revenues,” says Klassen.

With the notable exception of AED Oil (AED) which has revenue and opex largely in USD and Whitehaven Coal (WHC) which has USD exposure almost fully hedged for FY2010 – the currency impact on domestic resource stocks is predominantly negative. According to Tim Schroeders fund manager with Pengana Capital, its bulk commodity – iron ore, coal, minerals sands – producers that take the biggest currency hit when they miss out on rising commodity prices once annual contracts are locked-in. He says the ability of stocks like Whitehaven and to a lesser extent, Cochlear (COH) and QBE (QBE) to stave-off EPS decline, despite currency headwinds highlights the importance of currency hedging to dull the volatility of the AUD.

Other stocks Schroeders expects to face strong currency headwinds include: Incitec Pivot (IPL), Brambles (BXB), Resmed (RMD), Santos (STO), and PaperlinX (PPX). With high exposure to revenue sources in the US and Europe, PaperlinX is likely to cut its fiscal 2010 by up to 105 percent.

Given that they’ve got Australian operations with minimal hedging of the USD in 2010, Klassen says Western Areas (WSA) and Oz Minerals (OZL) are among a handful of stocks exposed to the biggest EPS decline in 2010. He says other stocks with greater exposure to EPS decline in 2010 include: Iluka Resources Limited (ILU), Centennial Coal Company (CEY), and Beach Petroleum Limited (BPT) which has opex largely in AUD and growing exposure to Egypt with revenue mix of USD and AUD.

Assuming currency is the only factor that moves, Deutsche Bank estimates that Qantas (QAN) will receive a 15 percent benefit to FY2010 EPS from a local currency at US95¢. But given that higher currencies typically give domestic importers superior pricing power when sourcing products and components from offshore – for sale locally – retail sectors are the standout beneficiaries of a runaway AUD.

While the AUD has risen around 9 percent against the USD in the past two months, discretionary retail jumped a corresponding 8.4 percent, with the consumer staples sector following on 5.2 percent. And while the resource sector gained only 2.9 percent, energy stocks lost 3.3 percent.

Klassen expects retailers sourcing cheaper goods out of Asia and selling locally to receive a margin boost from the high AUD. But given that lower costs eventually become a level playing-field, he expects those with more dominant market positions, like Harvey Norman (HVN) or higher-end specialty retailers like Myer Holdings (MYR), and David Jones (DJS) to retain greater margins for longer.

Included among retailers Klassen expects to reap a currency upside are: Breville Group (BRG), Fantastic Holdings Limited (FAN), GUD Holdings (GUD), Patties Foods (PFL), Premier Investments Limited (PMV), and Super Cheap Auto Group (SUL). But his three preferred retailers are: JB Hi-Fi (JBH), The Reject Shop (TRS) and quality furniture retailer, Nick Scali (NCK) – which has successfully offset USD exposure again higher margins.

But while greater buying powers does mean greater cost of goods sold (COGS) benefit, Klassen says the great unknown is how much of that upside they can actually pocket.  Which JB Hi-Fi is currently being revised, Klassen has target prices on Nick Scali ($1.27) and The Reject shop ($13.46) of $1.60 and 15.20 respectively.

Stocks To Win and Lose from Strengthening Currency

1)    Domestic importers (3-10 percent EPS growth upside)

Breville Group (BRG)

Fantastic Holdings Limited (FAN)

GUD Holdings (GUD)

JB Hi-Fi Limited (JBH)

Nick Scali (NCK)

Patties Foods (PFL)

Premier Investments Limited (PMV)

Super Cheap Auto Group (SUL)

The Reject Shop Limited (TRS)

2)    Domestic resources/exporters

 3-10% EPS growth upside  Modest Risk
EPS -3% to -10%

Moderate Risk
EPS fall -10% to -25%
 
Greatest Risk
EPS could fall by -25% percent-plus
 
 Whitehaven Coal (WHC) ARB Corporation (ARP)  Iluka Resources Limited (ILU)  Beach Petroleum (BPT)
 AED Oil (AED)  AWB (AWB)  Macarthur Coal Limited (MCC)  Centennial Coal Company (CEY)
     Felix Resources Group (FLX)  Kagara Zinc Limited (KZL)
     Independence Group (IGO)  OZ Minerals Limited (OZL)
     Panoramic Resources (PAN)  Western Areas NL (WSA)
     GrainCorp (GNC)     

 

3)    International resources/internationally exposed

 Modest Risk
EPS -3% to -10%
Moderate Risk
EPS fall -10% to -25%
 Greatest Risk
EPS could fall by -25% percent-plus

Citadel Resources Group (CGG)

 Kingsgate Consolidated (KCN)

 AWE Limited (AWE)

Molopo Australia Limited (MPO)

 Mineral Deposits Limited (MDL)

 Troy Resources NL (TRY)

Talent2 International Limited (TWO)

 Computershare Ltd (CPU)

 Viridis Clean Energy (VIR)

Savcor Group Limited (SAV)

 B&B Infrastructure (BBI)

 Infigen Energy (IFN)

Runge Limited (RUL)    

 

 

Nanosonics Limited (NAN)

 

 

Challenger Infrastructure (CIF)    

 

 

Biota Holdings Limited (BTA)

 

 

Acrux Limited (ACR)

 

 

 

Source: Wilson HTM

 

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