By  on August 19, 2014

LONDON — Luxury and fashion brands have been battling currency headwinds for the last year — but balmier days could be ahead.

Groups from LVMH Moët Hennessy Louis Vuitton to Prada to Burberry have all been battered by the strong euro and pound against weaker currencies, such as the Japanese yen and the U.S. dollar. The impacts have included instant stock price slides, profit downgrades and a smear on otherwise healthy quarterly growth. The weight of currency fluctuations has hit brands just as the economies in continental Europe slide back into recession and growth in the U.K. continues to sputter.

Last month, due to negative currency movements, Burberry Group was forced to lower its full-year profit guidance, overshadowing a 12 percent gain in first-quarter comp-store sales that was trumpeted by analysts.

The company warned that if the British pound remains as strong as it is today, reported retail and wholesale profit for the year ended March 2015 would be reduced by about 55 million pounds, or $93.7 million at current exchange, and that the adjusted operating margin would fall from 17.5 percent to about 16 percent. Burberry’s fiscal year ends on March 31, 2015.

In July, LVMH saw its share price slide 6.8 percent after it reported a weakness in the U.S. dollar and Japanese yen wiped 235 million euros, or $322.2 million, off its first-half profits. The timing — for LVMH in particular ­— was terrible. The strong euro bit just as the company reported an unexpected slowdown in demand from Mainland Chinese, Hong Kong and Russian customers.

It’s not only the luxury companies that have been suffering: On July 31, a week before it was due to release its second-quarter numbers, Adidas issued a profit warning, which forced its share price down 15.4 percent. The company pointed the finger at currency fluctuations, high marketing costs linked to the FIFA World Cup, and other factors such as tensions in Russia and Ukraine.

For public companies such as Burberry, which are posting impressive revenue and profit growth in currency-neutral terms, the impact of the strong pound has been particularly galling: “It’s frustrating to have to downgrade earnings, to watch the share price fall when your company is healthy and growing. It just reminds you of the pros and cons of global expansion,” said one financial analyst.

Luca Solca, managing director and sector head of global luxury goods at Exane BNP Paribas, said currency damage affects a certain type of investor. “Short-term investors are keener on short-term profits, and you can safely say [foreign exchange] hasn’t helped at all so far,” he said.

Most companies have sophisticated hedging programs in place. However, because they are forecasting their operating margins and fixing prices up to a year ahead, they can easily be zapped by unexpected currency movements. Even when those companies do get their calculations right, they then have the problem of converting international sales and profits back into their strong local currencies. That’s when the money gets lost in translation.

Yet companies can — and do — dodge the currency bullet. In May, Compagnie Financière Richemont, parent of brands including Cartier, Dunhill and Van Cleef & Arpels, notched a 3.1 percent gain in full-year profits to 2.07 billion euros, or $2.77 billion. The company, which operates from Switzerland, another country with a strong currency, said the figure was boosted by hedging gains.

The strong pound, buoyed by a rapidly recovering U.K. economy and the prospect of an interest rate in early 2015, has been a particular cause for concern. Over the past year, it has risen 11.3 percent against the dollar and nearly 10 percent against the euro. While the powerful pound may have British tourists salivating at the prospect of cheaper summer holidays at Disney World or on the Côte d’Azur, it has put international policy makers on alert.

Last month, the International Monetary Fund said the pound was “overvalued” by about 5 to 10 percent. A few days before that, the governor of the Bank of England, Mark Carney, talked to business leaders in Scotland about the “drag” on exports due to the pound’s double-digit appreciation over the past year. Carney also pointed out that demand from the U.K.’s traditional markets, such as Europe, is 25 percent below its pre-financial crisis trend.

The story is not all bad, however, and the future is looking increasingly bright. Analysts say they — and long-term investors — look straight past currency and fix their gazes on organic, currency-neutral growth instead.

“I don’t see much lasting damage from [foreign exchange], as companies typically adapt prices and cost structures to adjust in the medium term to the new currency environment,” said Solca.

“Hedges are effective for a limited period, typically one year. Take Japan, for example, where companies benefited from hedging for 12 months, but now have to adapt to a materially lower [yen] exchange rate. Long-term investors should be looking at underlying growth.”

Julian Easthope, a European luxury goods analyst at Barclays in London, would agree. “People look more toward organic growth rates, they know that currencies are volatile, and they take that in their stride,” he said.

At the same time, smaller luxury and fashion brands and retailers say the currency headwinds have not had a dramatic impact on business. “We buy our leather in euros, and our metal hardware in dollars, and that is balanced by our sales in the U.S.,” said Godfrey Davis, executive chairman of Mulberry. “None of this is disastrous — it’s something we can work with.”

Granted, most of Mulberry’s revenues come from the U.K., and its products are manufactured at its factories in Somerset, England and in Europe. “The sort of currency movements we’ve seen don’t suggest that we’d move prices. We’re trying to give people a fair deal.”

Topshop owner Sir Philip Green, whose business is based in the U.K., said he’s getting a boost from buying goods in dollars and in euros. “But then I’m giving it back on the sell [in foreign markets]. But the business mix is not too bad,” he said.

The future, at least for the euro, is looking up.

Solca, and others, said the euro will most likely weaken later this year, taking pressure off the French and Italian companies’ pricing and quarterly numbers. “[Foreign exchange] has been a significant headwind in 2013 and in the first half of 2014, but should cease being a headwind in the second half if the euro stops appreciating — which indeed seems to be the case,” he said.

In a recent FX Pulse report, analysts at Morgan Stanley said they’ve gone bearish on the euro for a variety of reasons, including geopolitical volatility in the region.

“The euro is currently the worst-performing G10 currency.…We believe this is just the start of a sustained move lower for the euro, against the U.S. dollar and more broadly.” The Morgan report added that the prospect of additional sanctions against Russia is also a potential negative factor for the euro.

“We do not see the euro as a safe haven from recent developments in Russia-Ukraine, especially given Europe’s high level of exposure to the region. Germany has one of the highest trade exposures to Russia, suggesting that further sanctions are likely to have a negative impact on growth prospects at the core of Europe. Germany also sources around 37 percent of its natural gas from Russia,” the report said. The bank also pointed to the dollar and yen as future safe havens.

Easthope, however, remains cautious about the outlook for the euro. “As a bank, we’re expecting a devaluation of the euro, but we are not doing our [European luxury] numbers on the basis of that, we’re not putting it into our forecasts. Predicting currency is one of the most difficult things [one can do].”

As for the pound, some banks are projecting a further 10 percent rise in its value later this year as the economy continues to gain steam. The IMF has revised upward its U.K. growth forecast for the year to 3.2 percent, and is expecting the figure to be 2.7 percent in 2015. The U.K. interest rate remains at the rock-bottom level of 0.5 percent.

As a result, Burberry will likely have another difficult few quarters, although the underlying outlook remains positive. “In the face of concerns about fading growth in the sector, Burberry continues to perform well above average,” Solca wrote last month, following Burberry’s first-quarter results and profit warning. “The brand maintains strong momentum in all product categories, and greatly benefits from its pioneering engagement in digital.”

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