U.S. Companies Just Lost Their Ace in the Hole

BOSTON (TheStreet) -- International revenue growth for big U.S. companies such as Johnson & Johnson (JNJ) and PepsiCo (PEP) is the one saving grace as the domestic economy grinds to a halt. Too bad the benefit of currency swings masks the real story.

U.S. large-cap companies are finding more opportunities in emerging markets. In previous quarters, the weakness in the dollar has made it cheaper for foreign countries to buy consumers goods from U.S. corporations. That resulted in American companies producing faster sales growth overseas.


That trend has remained intact. But in the third quarter, the U.S. dollar index increased, a sign of the greenback's strength against a basket of other currencies. Most notably, the U.S. dollar rose from about $1.45 per euro in May to nearly $1.30 per euro by the end of September. As a result, those glowing revenue numbers investors are cheering aren't as strong as they appear to be.

"You have to dig a little deeper than just looking at the top-line revenue figures. The headlines don't tell you the full story," says Robert Pavlik, chief investment officer with Banyan Partners. "The trends you're seeing are revenue increases, but they're currency-driven. You're in a slow-growth economy where the dollar is rising, which is not beneficial to U.S. multinational corporations."

The European debt crisis has been the key reason for the collapse of the euro against the dollar, and what companies have said so far about operations in the Eurozone is grim. The falling euro has become such a problem that the Swiss National Bank in early September set a minimum exchange rate of 1.20 francs to the euro, saying it would enforce that rate by buying unlimited quantities of the euro.

Though it's early into the third-quarter earnings reporting season -- only 61 companies in the S&P 500 are out with results so far, according to Capital IQ -- it's alarming to see that even as international sales growth outpaces that of the U.S., the currency translation is a big reason for the effect. That's a red flag investors should watch for in other multinational companies over the next few weeks.

What should investors take away, then, from what we've seen in the limited number of earnings reports? Let's break down large-cap U.S. company earnings:

¿ IBM ( IBM) said it saw revenue in Europe, Middle East and Africa climb 9%, although that was flat when adjusting for currencies. Revenue growth of 10% in the Asia-Pacific region was only 1% when adjusted. By comparison, U.S. revenue growth was up an adjusted 6%.

¿ Coca-Cola ( KO) reported a 45% surge in revenue from a year earlier, although the company benefitted from currencies as well as the acquisition of Coca-Cola Enterprises. As it turns out, the company had organic growth of only 1% in North America during the third quarter, and volume growth in Europe was essentially flat. Reported European net revenue for the quarter grew 5%, but that included a 6% currency benefit.

¿ Johnson & Johnson ( JNJ) saw U.S. revenue drop 3.7% from a year earlier while international sales jumped 16.4%. However, only 8.3% of the international sales increase was due to operations, with the other 8.1% coming from currency benefits.

¿ PepsiCo ( PEP) said net revenue in Europe jumped 37%, although that was partly driven by the company's acquisition of Russian dairy and juice company Wimm-Bill-Dann. Meanwhile, much of the company's net revenue growth in its Americas segment came thanks to Latin America, where food revenue jumped 19%.

¿ Parker Hannifin's ( PH) headlines lauded a 14% increase in sales to notch a first-quarter record of $3.2 billion. While organic sales growth was a strong 10%, foreign currency translation accounted for 3% of the total.

Paul Nolte, director of investments with Dearborn Partners, says it would be overstating it by saying that international sales growth is a mirage caused by the stronger dollar, but he agrees that it is a big headwind for these large-cap U.S. companies going forward.

"We'll see that persistence through this earnings season and into the fourth quarter," Nolte says. "Companies already have to increase their costs to increase their overseas businesses. When you tack on to that a higher dollar, it's creating more of a headwind. The international operations are still good, but not with a higher dollar. We're starting to see some of the effects now."

For investors who have been pitched the investment case that large cap U.S. equities are the place to be, these early trends are concerning. Nolte agrees, though he says there are "reasons to hold them," notably that they're the "best defensive names." Still, "you're losing some of the benefit because of the higher dollar."

So for those keeping track at home, multinational U.S. companies can't find growth in the U.S., so they hunt for it overseas. Unfortunately, the mix of costs to expand businesses and the higher dollar could dent profitability. And yet, this is one of the most attractive asset classes currently. No wonder investors want nothing to do with the stock market.

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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