Fool's Eye View

[ December 3, 1999 ]

Eurubbish

By Rob Davies (TMFEssex)

It's time to bash the euro again. At least that is what the markets think. Today it is flirting with parity to the dollar and shows every sign of going through it again at some point. This raises two questions: why is it doing this and what does it mean for investors?

I am no currency expert, but I have spent a lot of time watching currencies in the last decade and a half and there are usually a number of common threads. The first, and most important, is relative economic strength. Although the Eurozone is growing it is struggling to achieve rates much above 2% for the region as a whole. Sure, some areas like Ireland and Portugal are growing faster than that, and France is not doing too badly either. But the big German economy, and to a lesser extent Italy, are still stuck in the slow lane at around 1%. When your population is growing at the same sort of rate it means that GDP/head is static. And that is not good news.

Contrast that with the US where in the last quarter the economy grew by 5.5% and is showing every sign of maintaining that rate of advance. In simple terms it means this expanding economy is demanding more dollars, and that is pushing the price of money up to 6.3%. In the Eurozone demand is less vigorous so money is cheaper. It only costs 5.3% for 10-year money in Europe. Given a simple choice, where would you put your money?

Another big factor affecting currencies is the perception that Europe is not that keen on the free market. Intervention by the Schröder government to prevent the bankruptcy of Holzman, the second biggest construction company in Germany, has been taken very badly. If the banks don't think it a good idea to lend more of their money to patently incompetent managers, why should taxpayers? And, not surprisingly, Holzman's competitors take a dim view of it as well.

In France the government has been dragging its feet over opening up the electricity market to competition. It has been happy for EdeF, the state owned utility, to buy London Power and companies in Germany, but has yet to pass the legislation to allow foreign companies into its domestic market. These things don't go down well with international investors.

It looks therefore as if the fall of the euro to below parity with dollar is a no-brainer. That probably means it means it will fall against sterling as well because, thankfully, the British economy has got more in common with the US than with Europe.

A fall in the euro, and I am talking here of a decline of 10 or 15% once the technical trading around parity have been unwound, would have some dramatic implications for our portfolios. But what exactly?

For a start it would mean that British companies with assets in Europe would see a fall in the sterling value of this assets on the balance sheet. That means shareholders' funds would decline and increase the price-to-book ratio. It makes them more expensive on an asset basis. An example of that sort of company would be Unilever (LSE: ULVR), which has a lot of operations on the continent. Another company with a significant continental Europe asset base is Anglo American (LSE: AAL). It owns large quarries in Germany and Spain, so in sterling terms these will have a lower book value at the end of the year than they did at the start.

But companies making widgets in Europe and exporting to the UK, the US and elsewhere would experience a 10% fall in their cost base. With margins so tight in manufacturing that is a huge advantage, and would be similar to the kick the UK economy got when it was ejected from EMU in 1992. Only this time the boot is on the other foot and the UK suffers. For example, car component manufacturers such as Mayflower (LSE: MFW) will have a significant cost penalty when they supply BMW/Rover compared with a supplier from Germany. Good for BMW though.

A fall in the euro would of course have a major impact on the all those European unit trusts that people bought to get exposure to the growth generated by the formation of the euro. While shares in companies like BMW might go up in euro terms, once it is translated back into sterling it won't look quite so clever.

In a similar vein anyone lucky enough to have a second property in France or Spain will find that although the local price will have risen, translated back into pounds it will have not done quite so well overall.

But one real winner could be the holiday sector. Companies like Airtours (LSE: AIR) and Thomson Travel (LSE: TRV). Europe has suddenly become a much cheaper place to go to and the travel companies should be well placed to leverage their position as the conduit for punters to spend their pounds in Ibiza. But it might not be such good news for the airlines. British Airways (LSE: BAY) will suddenly find it has a 10% cost disadvantage against the likes of Lufthansa and Air France that will negate much of the good work it has done to get costs out of its business

The problem of imported deflation is going to affect a whole range of companies in a variety of industries. The moves Marks & Spencer (LSE: MKS) has been making to source more of its material from overseas can only be reinforced by these developments. That can't be good news for its domestic suppliers like Courtaulds (LSE: CTX) and William Baird (LSE: BDW).

Perhaps even those most defensive of stocks, the food retailers like Tesco (LSE: TSCO), Sainsbury (LSE: SBRY) and Sommerfield (LSE: SOF) might suffer. After all if food prices come down because of lower priced imports then sales growth is going to be pretty anaemic. That applies whether it's sold on the Internet or over the counter.

There is one area where the consumer should see a big benefit and that is car prices. Imported cars should, in theory, become much cheaper. If they don't we can buy them from Holland anyway. However, that probably is not good news for the car dealers like Reg Vardy (LSE: VDY). That collection of cars on their forecourt has just fallen 10% in value.

Those of us old enough to remember "white Wednesday" will recall the huge rally the UK market made on the back of the devaluation. My guess is that the effective revaluation of sterling now will be slightly negative for shares as a whole, but to nothing like the same extent. But, as ever, it will make stock selection even more important. The full implications of these developments will take some time to show themselves and some may be quite surprising. I am sure the list here is not exhaustive, so why not share your ideas with us and post a message on the Fool's Eye View message board, or perhaps on the Investment Strategies board.