The sharp fall in the value of the Australian dollar (AUD) has been a major topic of discussion in financial markets. The AUD has predominately fallen due to the relative strength of the US dollar (USD) but also due to prolonged weakness in commodity prices and mounting concerns over the growth outlook for China.
In terms of the Australian economy, few would argue that a falling AUD isn’t absolutely necessary to help offset the impact of falling commodity prices and to stimulate other key areas of the economy including education, domestic tourism and what remains of our manufacturing sector.
Despite the recent decline in the AUD from US$0.93 to around US$0.78, the Reserve Bank of Australia, in its commentary is still of the view that the currency “remains above most estimates of its fundamental value”.
Last year’s statement reiterated that the currency remains high and that “it is offering less assistance than would normally be expected in achieving balanced growth in the economy”.
Within the small cap universe, a falling AUD is typically a positive for:
•miners, as commodities are typically priced in USD
•those companies which have material offshore earnings (translational impact)
•domestic tourism and education providers, and
•for those companies which compete with imports.
On the flipside, it is negative for net importers, such as JB Hi-Fi or The Reject Shop, which source much of their product offshore in US dollars.
One of the investments in the small cap universe with the largest leverage to a falling AUD is Select Harvests (SHV). SHV grow, package and sell almonds to both domestic and international buyers,
with all sales (including domestic sales) based on international reference pricing.
The benchmark Californian pricing for almonds has been increasing in USD terms, which compounds with the weakening AUD to result in a greater increase in the AUD pricing. On the other side of the equation, SHV has almost all its expenses denominated in AUD which will result in increased margins. For example, a one per cent increase in the AUD almond price could result in as much as a two per cent uplift in profit before tax (before accounting for increased costs of fuel/chemicals etc, the price of which may escalate in a weaker AUD environment).
We expect the currency to stabilise around its current level in the near term as a number of competing factors offset each other. However it it needs to be noted that lowering interest rates could also affect the AUD.
Ordinarily the currency could be expected to remain under pressure relative to the USD as the terms of trade continue to decline and as key commodities, notably iron ore, remain weak.
However, recent strength in the USD and weak overseas growth has Federal Reserve officials concerned that the US economy could slow and inflation drop below the Fed’s two per cent objective. As a result, US interest rates are now not expected to rise until late 2015.
This development ought to help the AUD hold around its current levels in the near-term.
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