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Ever-Tumbling Euro Threatens to Squeeze U.S. Company Earnings

Could a selloff ensue if big tech firms feel the European currency's weakness?

That darned euro.

The European currency has continued to weaken against the dollar this summer, and U.S. companies with significant European sales are going to feel it where it counts -- in third-quarter earnings. Monday, analysts at

Goldman Sachs

identified

IBM

(IBM) - Get Report

as the euro's latest victim when they cut earnings estimates. Goldman said euro weakness will slash third-quarter earnings growth at Big Blue to 6.7%, from 10.3% on a constant-currency basis. The computer giant's shares fell 4%.

Other recent estimate cuts have pounded shares in chemical giant

DuPont

(DD) - Get Report

and soda bottler

Coca-Cola Enterprises

(CCE)

. Meanwhile, software giant and tech bellwether

Oracle

(ORCL) - Get Report

, expected to report earnings Thursday, counts about a fifth of its sales from Europe. A sign of currency weakness there could presage problems across the tech sector and put serious pressure on tech stocks.

Steep Slide

U.S. companies that do business overseas must convert foreign-currency earnings into dollars, a process known as repatriation. With the dollar steadily gaining strength against the euro since the European currency came into existence Jan. 1, 1999, sales made in Europe have been declining sharply in terms of their dollar value. It's the chief reason Goldman cut estimates on IBM, and it's partially the reason analysts at

PaineWebber

cut estimates for

Dow Chemical

(DOW) - Get Report

last week.

And that slide, which has seen the euro lose a quarter of its value against the dollar since inception, has only steepened in recent months. A 100 euro profit repatriated on June 30 brought $95; now such a transaction brings just $86. That can't help earnings for companies with big European sales, a group that includes many blue-chip names. And what's good for earnings is good for stocks -- and vice versa.

"U.S. stocks are going to face an uphill battle," said Thomas Van Leuven, strategist at

J.P. Morgan

. "Earnings growth has been decelerating throughout the course of the year and is going to next year, and the renewed dollar strength just adds to other pressures."

Some dismiss the issue, saying a currency translation problem doesn't signal fundamental problems with a business. But others call that an excuse.

"Currency translation or not, stocks are still valued by earnings, right?" says Allan Hickok, restaurant analyst at

U.S. Bancorp Piper Jaffray

. "So do you want to wish away something like currency?"

What's Good for Stocks ...

Large multinationals, basic materials companies, capital goods makers and the technology sectors are most vulnerable in this quarter, according to Joseph Kalinowski, analyst at earnings tracker

I/B/E/S

TST Recommends

.

Piper's Hickok covers

McDonald's

(MCD) - Get Report

, which shows 24% of 2000 sales (through August) from Europe. "McDonald's has enormous international expansion opportunities, but the bad news is that there are other issues related to doing business in foreign markets, and the risk to earnings from currency is one of them," Hickok says.

Other blue-chips with significant foreign sales include

Johnson & Johnson

(JNJ) - Get Report

, which counted 22% of second quarter 2000 sales from Europe;

Computer Associates

(CA) - Get Report

, which derives about 30% of its business from Europe and

Coca-Cola

(KO) - Get Report

, with a whopping 75% of sales classified as international.

Typically, companies try to combat currency weakness and the havoc it wreaks through hedging -- for example, by selling euros and buying dollars. But the euro has dropped quite sharply, further than most foreign exchange strategists, never mind company officials, would have expected. Through August, McDonald's European sales were flat from last year. Had the euro remained constant, however, sales would be up 10%.

Selling Pressure?

For the next few weeks, portfolio managers believe currency translation issues may be used as an excuse for selling stocks at a time when the market is already faced with looking at slowing year-over-year growth. They believe it could be an opportunity to add to positions.

"Any shortfalls from the euro may give people some excuses to be wary on stocks," says Joseph Keating, chief investment officer at

Kent Funds

in Grand Rapids, Mich. "I think most of

the selling will come in September, as opposed to October, when we get folks reporting earnings."

A number of other technology companies have significant European exposure that could eat into revenue growth, include

BMC Software

(BMCS)

,

Lexmark

(LXK)

,

Lucent

(LU)

and

Unisys

(UIS) - Get Report

.