Strong kiwi hides export successes

By BRIAN GAYNOR

If only the New Zealand dollar was 10USc lower.

That is all it would take for a number of companies, particularly the two Fisher & Paykel listed entities, to produce fantastic results.

The strong kiwi is camouflaging a number of outstanding export performances, and Fisher & Paykel Healthcare's interim result is an excellent example.

The accompanying table shows F&P Healthcare's six-month earnings in both New Zealand and United States dollars.

As the company has about 60 per cent of its sales in the US, the rise in the NZ dollar from US$0.5552 at the beginning of the 2003 interim period to US$0.6698 at the end of the latest period has had a big influence on the reported performance.

In kiwi dollar terms, sales grew by 11.9 per cent and net earnings after tax by 11.5 per cent, whereas on a greenback basis the increases were 24.4 per cent and 23.9 per cent.

F&P Healthcare has been able to compensate for the sharp rise in the New Zealand dollar through a combination of strong volume growth and an effective currency hedging strategy.

In US dollar terms, respiratory humidification revenue increased by 16 per cent, obstructive sleep apnoea products by 34 per cent and patient warming and neonatal care products by 46 per cent. These impressive figures show the large investment in research and development is now bearing fruit.

The group's foreign currency hedging policies had a $13.7 million positive impact on operating profit. Without this, earnings before interest and tax (ebit) in New Zealand dollar terms would have been $28.0 million, instead of the reported $41.7 million.

As far as hedging is concerned, the company is well positioned for the future. In US dollar terms, it is 95 per cent hedged through to the end of the March 2005 year at 0.4299 and 70 per cent hedged for the full March 2006 year at 0.4337.

This places F&P Healthcare in a good position for the next 18 months but group earnings will eventually be adversely affected by the New Zealand dollar unless it falls from its dizzy heights.

The group's next big project is the expansion of its East Tamaki operations. The current building has a book value of $48 million and the new building, which will be constructed next door, will cost a similar amount.

The additional production facility is needed to house the group's anticipated growth over the next few years. Earthworks have begun, tenders have been called and it is anticipated that the new facility will be completed by mid-2006.

This project, together with the $27.5 million share buyback programme and the high dividend payout ratio, will have a major impact on the group's cash position.

Cash and short-term investments have fallen to $39.2 million as at September 30 from $52.9 million a year earlier.

Over the next 18 months F&P Healthcare's cash reserves will be depleted and it will have net borrowings of between $20 million and $50 million.

This will be a drag on earnings, although interest costs associated with the new building will probably be capitalised until the project is completed.

The new East Tamaki facility shows that New Zealand continues to be the preferred base for Healthcare's research and development, now running at an annual rate of $15.5 million, as well as production.

This is good news for the New Zealand economy as the group could have considered moving overseas because of the high kiwi and as more than 90 per cent of its production is exported.

Fisher & Paykel Appliances reported a 1.2 per cent decline in net earnings to $34.5 million for the six months to September 30 even though its Finance Division raised operating earnings from $3.1 million to $15.6 million and appliance sales rose from 571,000 to 587,500 units.

The profit downturn was also due to the strong kiwi along with rising raw material prices, particularly steel and plastics.

The US continued its outstanding growth with sales of 97,700 units, up 34.9 per cent on the previous corresponding period.

But the NZ$/US$ cross rate had its impact on realisations, with the average unit price in New Zealand dollars falling from $962 to $916.

New Zealand unit sales were down 2.1 per cent to 150,900 and Australian volumes were off 3.4 per cent to 302,300, but Japan and the Pacific showed pleasing growth.

The company reported that currency translations eroded appliance revenue by approximately $10 million.

As far as the future is concerned, Fisher & Paykel Appliances' main exposure is to the Australian dollar, although the US dollar is becoming increasingly important.

It is 80 per cent hedged on its NZ$/A$ exposures at A$0.8773 through to March 31, 2005.

But the good news is that F&P Appliances is continuing to make impressive headway in the US. Its relationship with the Lowes retail chain is working well and the purchase of California-based Dynamic Cooking Systems last month will give it a manufacturing base in the US.

Both Fisher & Paykel companies have good prospects in the US. The big difference between the two is that Healthcare is keeping all its production in New Zealand, whereas Appliances is continuing to develop overseas manufacturing facilities.

As one would expect, overseas investors have done better from the strong overseas performance of the two F&P companies.

In the past twelve months, Healthcare's share price has risen 27.9 per cent, excluding dividends, while in US dollar terms it has appreciated 39.1 per cent.

Appliances' share price has increased by 15.9 per cent but in US dollars it is up 26.2 per cent.

Escalating oil prices are also having a negative impact on earnings, particularly for airlines, although effective fuel hedging has reduced the impact of these rises.

Jet fuel represents Air New Zealand's second largest cost after labour and in its rights issue prospectus released this week the company disclosed that the average jet fuel spot price for the first four months of its June 2005 year was US$54.23 a barrel compared to a spot price of US$42.75 as at June 30.

Jason Smith of Citigroup in Sydney has released figures showing that Air New Zealand has one of the more effective fuel-hedging policies in this part of the world.

Our national carrier is 61 per cent hedged at US$35.50 a barrel for a mix of West Texas Intermediate and Jet kerosene through to the end of the June 2005 year.

Only Qantas, which is 70 per cent hedged at US$32/bbl for Brent crude over the same period, has a higher hedging ratio in the Asia/Pacific region.

The two major discount airlines, Southwest in the US and Ryanair in Europe, have extremely aggressive hedging policies because they operate on tight margins and need to have a predictable and consistent cost structure.

Southwest is 80 per cent hedged through to December 2005 and Ryanair normally hedges 100 per cent of its jet fuel requirements 12 months forward.

The good news is that the two Fisher & Paykel companies and Air New Zealand are fundamentally strong but they are adversely affected by the high New Zealand dollar and rising oil prices.

Any easing in these two variables will help their earnings and share price performances.

From a long-term perspective, the strong New Zealand dollar is having a positive influence on our companies because it is forcing them to become internationally competitive.

By comparison, the constant currency devaluations in the 1970s and early 1980s had negative long-term consequences because the falling kiwi camouflaged major corporate inefficiencies.