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Treasury Risk
Management
Macro Trends and the
Implications for Corporations
Andre Secron
Head of Foreign Exchange Corporate Sales
and Structuring
Latin America
+1 (212) 723-1351
Treasury and Trade Solutions
1. Market Trend—The Strong US$ Cycle
2. The Implications of the Strong US$ for Corporations
3. Considerations for Hedging Policies
4. Key Takeaways
1. Market Trend—The Strong US$ Cycle
2. The Implications of the Strong US$ for Corporations
3. Considerations for Hedging Policies
4. Key Takeaways
70
90
110
130
150
1973 1978 1983 1988 1993 1998 2003 2008 2013 2018
History Suggests Continued Dollar Appreciation in Current Cycle
Since the inception of floating currencies, peak-to-trough cycles in the US$ have lasted between 6–9 years. With potentially 3–6 years remaining in current cycle, US$ may
strengthen by a further 10–30%. And while cycles may revert eventually, the long-run may encapsulate significant volatility impacting current performance.
US$ Since 1973
US Traded Weighted Real Major Currencies Dollar Index
6–7 years
60% (7.5% ann.)
7–8 years
(40)% (5)% ann.)
6–7 years
60% (7.5% ann.) ~9 years
(33)% (4)% ann.)
Current Cycle
Potentially 3–6 years
Remaining Potential 10–30%
US Corporations Benefited
Greatly from the Previous
9 year Cycle of US$ Weakness
Source: Bloomberg.
4
US$ Appreciation Projected Across the Board
Source: Bloomberg, Citi GEOS.
Note: Projections based on Citi FX forecasts. Market data as of 1/19/2015.
DM Currencies EM Currencies Commodity Currencies
10.9%
-0.6%
3.3%
-0.6%
2.6%
-6.6%
3.9%
0.4%
16.1%
13.7%
7.4%
11.6%
8.8% 8%
10% 10%
7.1% 7.1%
Current 3.22 634 15.1 2590 1.08 121 1.49 0.77 1.26 1Y Forecast 3.57 655 15.5 2690 0.93 130 1.37 0.7 1.35
Long Term 3.2 630 14.1 2600 0.95 135 1.38 0.7 1.35
MXN
5
US$ Appreciation within Latin America Context
Source: Bloomberg.
80
100
120
140
160
Dec-1
2
Ja
n-1
3
Ja
n-1
3
Feb-1
3
Feb-1
3
Ma
r-13
Ma
r-13
Apr-
13
Apr-
13
Ma
y-1
3
Ma
y-1
3
Ma
y-1
3
Ju
n-1
3
Ju
n-1
3
Ju
l-1
3
Ju
l-1
3
Aug
-13
Aug
-13
Sep
-13
Sep
-13
Oct-
13
Oct-
13
Nov-1
3
Nov-1
3
Nov-1
3
Dec-1
3
Dec-1
3
Ja
n-1
4
Ja
n-1
4
Feb-1
4
Feb-1
4
Ma
r-14
Ma
r-14
Apr-
14
Apr-
14
Ma
y-1
4
Ma
y-1
4
Ma
y-1
4
Ju
n-1
4
Ju
n-1
4
Ju
l-1
4
Ju
l-1
4
Aug
-14
Aug
-14
Sep
-14
Sep
-14
Oct-
14
Oct-
14
Oct-
14
Nov-1
4
Nov-1
4
Dec-1
4
Dec-1
4
Ja
n-1
5
Ja
n-1
5
Feb-1
5
Feb-1
5
Ma
r-15
Ma
r-15
USDBRL USDCOP USDCLP USDMXN
6
US$—The Multi-Year Bull Trend: Why?
Stronger Expected US
Economic Growth
Declining unemployment rate (under 6%)
Strengthening activity in industrials and
service sectors
Improving personal consumption
expenditures
3% forecasted GDP growth in 2015–2016
Divergence in Central
Bank Action
Sustained US economic recovery
supporting US Fed tightening
Persistent sluggish growth in Eurozone and
Japan supporting further easing
Unexpected central bank actions (i.e.
removal of EURCHF floor) drive volatility
Lower Oil Prices
Oil producing countries experiencing
declining revenues, increasing budget
deficits, and adverse exchange rate impact
Slowdown in Expected
EM Growth
China’s slower transition towards a
domestic consumption driven economy
Broader EM headwinds due to current
account deficits
GDP growth slowing to low 7% in China
Expectation of Sluggish Growth
in Eurozone and Japan
Persistent low/negative inflation despite
unprecedented easing
Weak labor markets with
structural challenges
Stronger
US$
7
1. Market Trend—The Strong US$ Cycle
2. The Implications of the Strong US$ for Corporations
3. Considerations for Hedging Policies
4. Key Takeaways
Strong Dollar Already Affecting Corporates
Our largest exposure remains the euro. […] we’ve hedged
roughly 50% of our 2015 euro exposure […] Considering
these impacts, FX will be a sales headwind for 2015 [ … ],
which works out to about $0.10 per share.
Dollar’s rise against the ringgit was partly to blame for
lower quarterly revenues. About 70% of the company’s
debt is in U.S. dollars, and its bond yields spiked as the
ringgit fell nearly 9% in the past six months.
3M estimates that year-on-year currency effects, including
hedging impacts, decreased net income attributable to 3M
by approximately $10 million for the three months ended
September 30, 2014.
The net income and EPS include a charge of EUR 180
million from negative FX revaluation in the third quarter
due to the strong strengthening of the dollar. […] we
increased the pace of hedging activity due to the favorable
dollar environment.
Source: Bloomberg.
9
Stronger US$ Impacts Multiple Corporate Dimensions A stronger US$ impacts corporates across the financial statements, potentially pressuring margins, overseas valuations, and the
ability to compete in the future. Prudent risk management can help to mitigate these concerns.
Timing mismatch between contract and payment in a foreign currency
Competitor pricing
Lower channel costs
Mismatches between sales in one currency and costs in another currency
Market volatility as well as uncertainty in revenues
Foreign-based subsidiaries may create earnings volatility
Can impact earnings per share (EPS), credit ratings and cost of capital
Potential covenant breaches
Interest cost can be minimized
Match currency exposure of cash flows (CF) and net assets
Protecting shareholder’s investments in foreign subsidiary
Expected repatriation of overseas cash
Increasing global footprint
Potential cross-border acquisitions
Internal investment: Predicable cash flow = more investment
Sufficient liquidity
Operational
Financial
Economic/Strategic
Transactional
Cash Flow
Operating Earnings
Debt/Liabilities
Assets
Business Growth
Competition
Capital
Income
Statement
Balance Sheet
10
Who are Most Impacted?
Multinational Corporates
US multinationals with significant
sales abroad will see their foreign
cash flows erode
Non-US multinationals with US
revenue exposures will benefit from
stronger US$
Non-US multinationals that fund in
US$ will see negative impact on their
balance sheet as US$ strengthens
US$-Funded EM Corporates
EM multinationals with large US
revenue exposures will benefit from
stronger US$
EM multinationals that fund in US$
will see negative impact on their
balance sheet as US$ strengthens
Global Commodity Producers
While revenues of foreign oil
producers will decrease due to falling
oil prices, a stronger US$ will
mitigate the negative impact
US producers will benefit from
lower foreign production costs as
US$ strengthens
Careful analysis is key to
understanding how FX/commodity
correlation impacts corporate top and
bottom lines
11
1. Market Trend—The Strong US$ Cycle
2. The Implications of the Strong US$ for Corporations
3. Considerations for Hedging Policies
4. Key Takeaways
Traditional Hedging Programs Static Hedging Program
Hedges for the entire year implemented at one single point
in time
Rolling Hedging Program
Hedges are implemented throughout the year as new forecasts
become available
Provides predictability of the value of future transactions over a
defined period of time
Layered Hedging Program
Similar to a rolling program in that hedges are implemented
throughout the year
However, in an effort to create smoothing the hedge ratio is
built-up over time
Static Hedging Program
Rolling Hedging Program
Layered Hedging Program
13
A Customized Solution to Protect Against US$ Strength
Front-loading the hedging schedule to increase value at risk (VaR) reduction
Adding options to the mix of hedge instruments to maintain the flexibility lost from front-loading. This is particularly important as the
strengthening in the US$ is unlikely to be in a straight line over time
Standard Layered Hedging
Dynamic Layered Hedging
Extending hedge duration
14
Portfolio Diversification Portfolio diversification can be a powerful tool to stabilize the performance of a hedging portfolio. In particular, the strategy is highly
effective in periods of increased market volatility.
CitiFX ran a backtest analysis of the hypothetical performance of four different hedging strategies and an unhedged portfolio
The simulation assumes a quarterly rolling hedging strategy. Follows ahead the results of the combined portfolios
Hedging
Period
FX Spot at
Beginning
FX Spot at
End Forward Strategy A Strategy B Strategy C Portfolio1 Portfolio 2
1Q13 13.68 12.61 13.92 13.64 13.50 13.92 13.16 13.42
2Q13 12.96 12.27 13.21 12.95 12.82 13.21 12.64 12.81
3Q13 12.61 12.62 12.84 12.59 12.46 12.62 12.58 12.57
4Q13 12.27 12.99 12.46 12.39 12.99 12.55 12.88 12.73
1Q14 12.62 13.51 12.83 12.68 12.44 12.90 13.09 12.88
2Q14 12.99 13.11 13.17 12.90 12.77 13.11 13.02 12.97
3Q14 13.51 12.96 13.69 13.42 13.28 13.69 13.22 13.34
15
Portfolio Diversification (Cont’d)
12.00
12.50
13.00
13.50
14.00
1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014
FX Spot at End Forward Portfolio1 Porfolio 2
FX Spot at End Forward Strategy A Strategy B Strategy C
Portfolio 1 50% 0% 0% 25% 25%
Portfolio 2 25% 0% 25% 25% 25%
16
1. Market Trend—The Strong US$ Cycle
2. The Implications of the Strong US$ for Corporations
3. Considerations for Hedging Policies
4. Key Takeaways
Key Takeaways—Risks, Implications and Solutions
Risks
Implications
Solutions
Widening growth prospects between US and rest of world, and sustained divergence in central bank policies will
drive US$ stronger in current cycle. Meanwhile, corporates have become more global with a higher percentage
of revenues coming from overseas
Exposure to FX risk is a predominant driver of earnings volatility, while changing volatility and correlation
dynamics today may negatively impact corporate earnings
The turn of US$ cycle from weakness to strength requires corporates today to review and adjust their risk
management strategies
Holistic assessment of a corporate’s market risk exposures that takes into consideration correlation and volatility
dynamics are critical to effective risk management
Effective risk management can potentially boost valuation and improve growth prospects. Corporates should
adjust hedging strategies and capital deployment policies in today’s strong US$ cycle
Stronger US$ may affect corporates in multiple dimensions, with implications on cash flows, balance sheets, and
business strategies
The implications vary for different types of global corporates, depending on their market risks exposures
Many corporates have reported negative impacts from US$ strength in recent quarters with potential for more
downside risk in coming quarters
18
Key Takeaways—Tangible Results
“…dollar COGS hedge is the most “attractive” in several years. A second factor is, following Citi’s recently revised f/x estimate, the value of
Ambev’s dollar COGS hedge for 2015 has increased significantly. This is true both for its own earnings growth potential as well as relative
to its beverage peers (brewers and bottlers alike) who either can’t hedge their dollar-linked COGS against a weaker f/x or hedge less
effectively. We incorporate Citi’s average 2015 real/dollar f/x estimate of R$2.83 (from Jan/26), 13% weaker than the estimate in October
(before the elections), implying a 20% depreciation YoY. More importantly, this average market rate is well above our assumption of an
average R$2.35 for Ambev’s 2015 dollar COGS hedge in Brazil, which we believe no other beverage peer has. R$2.35 implies a 7%
weaker hedge than 2014 (when it was 15% higher YoY), suggesting less pressure compared to prior years. The benefit of the hedge is
partly offset by less favorable commodities hedge this year versus last year.”
Alexander Robats, Head of Citi's Latin American Consumer Staples Equity Research team. In the Food/Beverage/HPC sectors –
January 28th, 2015
“Based on a less onerous beverage tax (see note), more than expected Brazil margin expansion, recent sharp currency
depreciation (increasing the value of its dollar COGS hedge), and an undemanding valuation, we argue Ambev’s de-rating is over
and upgrade to Buy.”
19
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