Dollar rebound a growth drag for U.S. industrials

By Scott Malone - Analysis

BOSTON (Reuters) - The U.S. dollar's recovery from record lows could remove a major factor that has allowed diversified U.S. manufacturers to post strong profit even as their home economy has stumbled.

The dollar's drop over the past few years has boosted revenue for U.S.-based multinationals, making their products less expensive in foreign markets and boosting the value of overseas revenue when translated into dollars.

The currency's rebound raises a new worry for investors, particularly because many industrial companies' second-quarter profit growth reflected stronger revenue rather than fatter margins.

After sliding in value since early 2006, the dollar has rebounded from lifetime lows hit in March. It has gained about 5 percent in value against the euro just this month and is now worth about 77 euro cents.

For companies including United Technologies Corp (UTX.N: Quote, Profile, Research, Stock Buzz), Honeywell International Inc (HON.N: Quote, Profile, Research, Stock Buzz) and Caterpillar Inc (CAT.N: Quote, Profile, Research, Stock Buzz) that generate much of their sales outside the United States, a further worry is the reason for the dollar's rebound -- fears that the European economy is slowing.

"It's going to be very difficult for companies to maintain the margins they have had the last couple of quarters," said Wayne Titche, co-manager of the AHA Diversified Equity Fund in Grand Rapids, Michigan, which counts Caterpillar and General Electric Co (GE.N: Quote, Profile, Research, Stock Buzz) among its holdings. "But a lot of that is already priced into the stocks."

While the dollar rebound can hurt revenue, it can also help boost companies' profit margins by making commodities cheaper. That leaves investors wondering if its climb will become dramatic enough that the pain will offset the benefit.

"It is a matter of how much the dollar strengthens versus the euro," said Jim Huguet, outgoing chief executive of Great Companies, a Tampa, Florida-based money manager that counts United Tech among its holdings. "If you're talking in the 10 percent range or higher than that, then you start to have an impact on sales."

VARIED EFFECTS

Most U.S. industrial companies have experienced some revenue boost from the weak dollar. Deutsche Bank analyst Nigel Coe, in a note to clients, estimated that it lifted the sector's revenue by 5 percentage points in the second quarter.

But the effect varied widely. Agricultural equipment maker AGCO Corp (AG.N: Quote, Profile, Research, Stock Buzz) attributed about 13.4 percentage points of its 40 percent surge in second-quarter sales to the weak dollar, while Honeywell said currency accounted for 3 points of its 11 percent growth. Caterpillar also credited the weak home currency for 3 points of its 20 percent growth.

Food and consumer-products companies, including Kraft Foods Inc (KFT.N: Quote, Profile, Research, Stock Buzz), HJ Heinz Co (HNZ.N: Quote, Profile, Research, Stock Buzz) and Procter & Gamble Co (PG.N: Quote, Profile, Research, Stock Buzz), have also benefited from the dollar's slide.

Companies that make equipment in the U.S. and ship it overseas felt more of a boost than those that manufacture abroad for foreign markets. A GE spokesman said currency fluctuations have no significant effect on the conglomerate's financial results because of its extensive foreign manufacturing operations.

NOT ALL NEGATIVE

While the dollar's rebound will be a drag on companies' top lines, it will also provide some boost to profit margins -- as a stronger dollar makes key commodities including oil and steel seem relatively less expensive for U.S. companies.  Continued...