Emerging currency rout to squeeze European profits on consumer staples

Tue Sep 3, 2013 2:22pm BST

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* Weaker currencies in the emerging world to dent demand

* Beverage, staple firms exposed to Brazil, S.Africa, India

* High-end consumer goods in China could be insulated

By Alistair Smout and Atul Prakash

LONDON, Sept 3 (Reuters) - European companies that have ridden a boom in sales to Brazilian, Indian and South African consumers now face an uncomfortable third quarter as currency routs crimp demand and weigh on profits.

Consumer staples companies are expected to bear the brunt of prolonged currency weakness in these and other prominent emerging economies since the U.S. Federal Reserve began to talk of running down the policy that has pumped cheap cash around the world.

While currency weakness will take a widespread toll on demand, the impact is particularly evident in the share prices of companies such as UK-listed Unilever, down nearly 13 percent since mid July, and Reckitt Benckiser, down 6.3 percent in August.

By contrast, shares in Dutch retail group Ahold, which focuses on developed markets, fell just 2.7 percent in August.

The sudden weakening of local currencies forces European firms to decide whether to pass local price rises on to squeezed consumers or lose margins on each sale - with either option set to hit profits next quarter.

Brazil's real, India's rupee and the South African rand slid by between 4 percent and 8 percent against the dollar in August while the Thomson Reuters European Consumer Staples index , which had risen twice as fast as the broader index by May, lagged the DJ Europe STOXX by more than 2 percentage points.

"European companies can handle currency devaluation in the case that it is slow and steady, but there could be problems if the process is sudden and fast," said Christian Stocker, equity strategist at UniCredit, adding that the speed of the recent devaluations was "extreme".

"There is a high risk that these could get reflected in the third quarter earnings."

Consumer staples constitute 19.7 percent of the MSCI World with Emerging Market Exposure index - the highest weighting of any sector.

LUXURY STILL IN VOGUE

While few dispute the long-term emerging market growth story, the near-term assessment is likely to be much more nuanced, with renewed focus on official interest rate rises to defend currencies, the struggle to finance current account deficits and the degree of political unrest in each country.

For instance, AB Inbev, which derives 30 percent of its revenue from northern Latin America, has lost 4.9 percent as the Brazilian real has weakened, while Diageo, with 20 percent exposure to Africa, has dropped 7 percent as the South African rand has fallen to a four-year low.

Brazil, along with India and Indonesia, has subsequently tightened monetary policy to try and protect the local currency, squeezing companies such as Unilever, which gets 55 percent of its revenues from emerging markets including these three.

"If you take Unilever, or Diageo, for example, then they are exposed as the consumer in emerging markets starts to feel the pinch," Gerard Lane, equity strategist at Shore Capital.

"The consumer staples are going to see their earnings adversely affected in the coming quarters."

Unilever's earnings forecasts have been downgraded by 4.1 percent over the last 90 days and Diageo's by 1.1 percent, Thomson Reuters StarMine data shows. Diageo has 20 percent exposure to Africa, focussed in South Africa, although local production helps limit imported price rises.

EM-exposed stocks are at risk of a double whammy as European focussed stocks, many of which are in the most crisis-hit corners of the euro zone, look more attractive on a valuation basis on the view that the economy has troughed.

For instance, UK-focussed supermarket Morrisons trades at 11.4 times price to earnings, Thomson Reuters StarMine showed, compared to Unilever at a 17.5 multiple.

Emerging market consumers are not likely to be uniformly affected, however. Luxury names like LVMH and Burberry should find the spending power of their affluent customers among the least affected, with currency controls in countries such as China also helping to support demand.

Morgan Stanley's China Pulse for August found that Swiss watch sales and sales of jewellery and gold both reaccelerated by over 40 percent year-on-year last month.

Near-term nervousness may obscure better longer-term prospects.

"Even though growth rates are slowing in the emerging world, expectations have also moved a long way," said Robert Parkes, equity strategist at HSBC Securities. "The consensus may now have moved from a position of too much optimism to too much pessimism."

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