I've commented recently how the real earnings power of several softline companies with international exposure has been masked by different levels of investment over the past several years. With a smooth 40% slide in the dollar over 5 years (most notably, the last 3), my strong feeling is that even the most sophisticated CEOs are underestimating the extent to which favorable FX trends have boosted both their margins and competitive positioning. The better teams have upped the investment ante in this context, while the weaker ones have let the benefit disproportionately flow throw to the margin line. The 3% rise in the Dollar vs the Euro over the past 6 weeks is still short of the point where we'd consider it a 'trend' vs. a 'trade' but mark my words - if the recent trade holds and the dollar strengthens, some companies will be in for a very rude awakening. Biggest losers - GES, WRC, SKX. Best positioned - LIZ, TBL, RL and to a lesser extent ZQK. Check out Exhibit 3 below. Consider the following...
- European exposure is clearly something to consider given the hiatus we're seeing in the Euro's climb vs. the Dollar. But where I think it gets interesting is when we look at the change in Europe as a percent of total sales over the same time period we saw the massive 40% FX swing. On top of that, we can look at how the company's margin structure changed.
- While some company-specific drivers need to be considered, it's impossible to ignore such a massive rise in European sales in tandem with incremental margin improvement at select companies. These include GES, WRC and SKX (they just happen to be my least favorite names now - for other reasons as well).
- The best positioned companies (or the least poorly positioned) include those that have had an increase in Euro as a percent of total yet have still had margins down. These companies are not without some fleas, but the analysis shows how they have upped investment levels when faced with company-specific challenges or global growth opportunities. These include LIZ, RL, TBL and ZQK. With these companies, I think we're at a point where we will either 1) harvest investment spending, or 2) cut free up invested cash that is not yielding appropriate returns. In other words, margins should still go up regardless of which way the Euro goes.