The Weekly (11/4)

This Weekly was guest-written by Austin Hankwitz and Christian Blackwell of ‘Rate of Return’ Substack, and is exclusively available on Titan.

As the dollar continued to strengthen during the quarter, the foreign exchange impact was higher than the 390 basis point impact we had incorporated into our Q3 guidance. This represents a headwind of approximately $900 million, more than we initially guided to.”

– Brian Olsavsky, CFO of Amazon

“Based on our YTD actuals and Q4 guidance, we estimate that this [US dollar] appreciation since January 1, 2022 will negatively impact our full year 2022 revenue and operating income by ~$1 billion and $0.8 billion, respectively.”

– Netflix Q3 Shareholder Letter

In 2010, an American travel website and blog named The Points Guy was founded by Brian Kelly. Brian would teach people how to maximize their credit card points for travel-related benefits – essentially teaching people how to travel the world for free. And who doesn’t want to travel for free? Just the other week, Delta Air Lines and Starbucks announced a partnership that rewards customers with travel benefits. 

A few things happen when you travel outside of the country – you forget a port converter for your cell phone charger, and you’re reminded by your friends & family to find a trusted currency exchange center. 

As you’re well aware, different countries around the world require their citizens to conduct business in different currencies. Here in the United States the US dollar is legal tender. However, in France the Euro is legal tender. Which means if you had plans to travel to Paris, you’d need to exchange your US dollars for Euros. 

The amount of Euros you’re able to receive in exchange for your US dollars changes all of the time for various reasons. As of writing this, one US dollar is equal to one Euro. However, a year ago in August of 2021, one US dollar was only equal to 0.85 Euros. 

Which means in relation to the Euro, the US dollar has strengthened. The same one US dollar now buys you +17% more Euros than it did just last year. 

Well that sounds like fun, right? The money we all work so hard to make is now worth more in relation to the Euro than it was a year ago. Which means if you traveled to France today, you’d have +17% more buying power than you would have had last summer. Did someone say shopping spree? 

Now this might sound wonderful for the everyday person like you and me – but it’s the opposite for US-based companies generating revenue around the world. Remember, these companies at the end of the day are headquartered in the US – which means they report their earnings to their shareholders in the form of US dollars. 

They pay their employees in the form of US dollars. They reinvest back into their business in the form of US dollars. They pay taxes to the government in the form of US dollars. Let’s pretend you’re the CEO of a US-based company who generates 50% of their revenue in the US, and 50% of their revenue in France. Let’s also pretend in 2021, you generated $100 million (USD) in revenue – $90 million of which went to operating your business, and the other $10 million was realized as profits. 

Today, assuming the same 50/50 split and that you don’t raise your prices on your customers – the $50 million (USD) in revenue you’d expect to generate in France is now only worth $41.5 million (USD). Nothing changed – you’re now just left with -17% less revenue because of how the Euro has lost value in relation to the US dollar. 

Assuming you spend the same $90 million in expenses to operate your business, you’re now left with just $1.5 million in profits. That’s an -85% decrease in profits from a +17% change in currency prices. 

Some of the largest companies in the country (specifically Amazon and Netflix shown above) are seeing these currency changes ripple through their operating margins – causing haircuts to the tune of billions of dollars. 

But why is the US dollar so strong all of a sudden? 

Two reasons – the Fed’s hawkish monetary policy and the US economy. 

The Federal Reserve has been raising interest rates at the fastest speed in history, with the intent of slowing down our runaway inflation. Considering core inflation during the month of September hit a 40-year high.. we still have a long way to go. 

The Bureau of Economic Analysis (BEA) recently shared that the GDP during Q3 rose +2.6% – compare this to the -0.6% contraction we saw in Q2. There are countless ways to measure the strength of the US economy, but generally speaking there aren’t flashing red lights coming out of every economic report just yet. 

This gives the Federal Reserve assurance that they can continue to either raise interest rates or keep rates high for a longer period of time – all in efforts to slow down the economy. Considering what they’ve done thus far 1) hasn’t yet crushed demand and 2) hasn’t substantially slowed down the economy… the ball is still in their court.

What does this mean for you, the investor? 

Not much. Companies of this size plan for these types of events – even Amazon mentioned they were assuming a strong US dollar during Q3. However, if you’re analyzing a company’s earnings results – be sure to look for the phrase “in constant currency.” 

When companies report earnings “in constant currency,” they’re sharing with you the results as if there were no foreign exchange headwinds. When analyzing a company’s financial situation, it’s important to follow revenue trends in constant currency. This allows you to more accurately compare results year-over-year.

If you enjoyed reading this digestible analysis – be sure to drop your email to Austin & Christian’s Substack community, Rate of Return. They deliver curated financial news, commentary and analysis to your inbox 2-3 times per week.

Titan’s Takeaway: With a stronger US dollar, domestic companies that generate substantial revenue abroad are beginning to see foreign exchange headwinds impact their margins. This dynamic has the potential to weaken earnings and has been a popular topic on recent earnings calls.

However, the opposite is true for foreign-based companies that have operations in the United States, and investors in these companies could be rewarded - a potential tailwind for our Offshore strategy. In truth, it’s not a fundamental tailwind that we put too much value into.

While currency headaches have been one of the loudest talking points in earnings calls this season, its impact has historically reverted to the mean over time. Given nobody knows with certainty if or when the dollar will reverse its course, we tend to focus on how the macro may impact company fundamentals, which historically have been a much better indicator of long-term success.

Three Things

1) BOE Hikes Rates Again: The Bank of England followed the United States' Fed and raised interest rates by 75 basis points. The BOE remarked that the economy most likely fell into a recession in September as the economy continues to get battered by high prices. The increase is the largest since 1989 and takes borrowing costs to their highest level since 2008.

Titan's Takeaway: The U.K. economy is poised to enter a period of a prolonged downturn. With runaway inflation seeping into all sectors of the economy, from energy to food, households are set for an expensive and brutally cold winter.

2) Stripe Announces Layoffs: Stripe is set to cut 14% of its workforce as the company tries to tighten its belt and lengthen its runway with funding dried up and a recession looming. CEO Patrick Collison, in an employee memo, conceded to overstating the growth of the internet economy in 2022 and 2023. Stripe continues to postpone its IPO as its once stratospheric $95 billion valuation looks dubious in this tumultuous market.

Titan's Takeaway: Stripe's sizable layoffs show that even class-A start-ups are feeling the heat of the rising rate environment. It's a new normal in private markets, and valuations will be reassessed accordingly.

3) Dick's Sporting Goods enters VC: The sporting goods retailer is walking into a new arena as it unveils a $50 million venture capital fund. The initial investments so far include a sporting goods marketplace, women's basketball shoes, and a youth sports operator. Dick's new venture arm follows Nike, Adidas, and Under Armour's respective investment businesses.

Titan's Takeaway: Finding creative ways to grow is paramount to staying alive in the competitive sports apparel industry. For Dick's Sporting Goods, venture may provide another lucrative avenue to find innovative and disruptive products.

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