Loonie Gain Packs Less Punch for Canada's Continental Firms
The Canadian dollar didn’t boost manufacturers as much as hoped on its way down. That probably means it won’t hurt them as much as feared on the way up.
The loonie hit 80 U.S. cents for the first time in more than a year on Monday, up about 10 percent since early May, raising concerns that manufacturing exports could shrink just as they were beginning to gain traction. But the Canadian economy is better equipped to handle a stronger currency than it used to be, said Benjamin Reitzes, director of Canadian rates and macro strategist at BMO Capital Markets.
“We’re not as sensitive to the exchange rate as we once were,” Reitzes said in a phone interview. “Because the global economy and manufacturing in particular is so globally integrated now, over time that exchange-rate factor matters a little bit less than it did 10 or 20 years ago.”
Like many major economies, manufacturing has shrunk in Canada as a growth driver. The last time the loonie started a long-term appreciation cycle in late 2002, manufacturing accounted for about 14 percent of the economy. Today, that number is 10 percent.
The Canadian dollar slipped Wednesday to 79.87 U.S. cents at 9:09 a.m. in Toronto. One U.S. dollar bought C$1.2523.
Winnipeg, Manitoba-based New Flyer Industries Inc., the largest transit bus manufacturer in North America, is typical of a Canadian company building out its continental footprint. It now has a significant amount of operations in the U.S. after an acquisition spree south of the border and reports in U.S. dollars.
Approximately 88 percent of the company’s revenue was U.S. dollar-denominated in the first quarter and most of its material costs are also in greenbacks, Jon Koffman, head of investor relations, wrote in an email. For those costs that are denominated in Canadian dollars, New Flyer enters into foreign-exchange forward or option contracts to hedge against fluctuations.The shares have returned almost seven-fold, including dividends, in the past five years.
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The 13 Canadian companies on the 26-member S&P/TSX industrials index that break out U.S. revenue generate 40 percent of their sales south of the border on average, according to data compiled by Bloomberg. The industrials sector is the best performer on the S&P/TSX Composite Index over the past 12 months, with a gain of 16 percent. Companies in the broader composite index also generate 40 percent of their sales in the U.S. on average, according to the 72 firms that separate the data out.
Of course the loonie is appreciating for a reason. A strengthening economy on both sides of the border is boosting employment, revenue and profit at Canadian companies. Merchandise exports hit a record high in May, exports to the U.S. have never been stronger and central banks on both sides of the border have been tightening monetary policy.
Gross domestic product grew an annualized 3.7 percent in Canada in the first quarter and the U.S. economy has been steadily expanding as trade between the two North American Free Trade Agreement partners picks up.
Still, the Canadian economy isn’t immune to a higher dollar.
“The dollar obviously affects our earnings,” Keith Creel, chief executive officer of Canadian Pacific Railway Ltd., said in a July 19 interview. “There are puts and takes with the dollar. The grain harvest is my biggest concern. We will know by the end of the third quarter. By that point we will understand the effects of the strengthening Canadian dollar as well.”
Canadian National Railway Co. also said Tuesday the currency’s appreciation will weigh on earnings in the second half.
Denis Dussin, president of Woodbridge, Ontario-based Alps Welding Ltd., said his company tries to hedge against currency fluctuations but it can’t always protect against rapid appreciation.
“When we have a low Canadian dollar we have an advantage against our American competitors that we’re bidding against and when the Canadian dollar goes up, that advantage is less,” Dussin said in a phone interview. “When it’s going up the way it has been now, you know we feel that pain.”
At current levels, the Canadian dollar is slightly below its 20-year average of 82 U.S. cents, a position that shouldn’t be overly harmful to most Canadian companies.
“It’s still probably a little bit premature for significant concerns,” Reitzes said. “If we get through that 80-cent area and continue to move higher, you probably are nearing an area where businesses start to get a little bit more uncomfortable.”
Market positioning has caught up to the currency’s rally, with hedge funds unwinding record short positions to turn bullish on the loonie for the first time since March. There’s more room for bulls, too — while the current net long stance is about 8,000 contracts, it was more than 30,000 in February. Oil, a traditional loonie driver, has also been rising, with West Texas Intermediate, the North American benchmark, gaining about 13 percent since June 21.
The loonie’s flight path still has hurdles. The market is already pricing in almost an 80 percent chance of another rate hike this year, leaving little room for more optimism in the exchange rate. Analysts aren’t convinced of the rally, either. The median forecast for USD/CAD sees the pair reaching C$1.30 by the end of 2017, according to data compiled by Bloomberg.
Dussin at Alps Welding, which works in various industries including oil, gas and power generation, said a stronger currency may help cut the costs of the U.S. imports it buys such as steel.
“Some of our inputs might get a little bit cheaper,” he said. “I wouldn’t say it’s enough to offset the disadvantages but it helps.”