Analysis: Sliding euro is U.S. manufacturers next big worry

By Scott Malone and Nick Zieminski

BOSTON/NEW YORK (BestGrowthStock) – The falling European currency, which hit a fresh four-year low early this week, is emerging as the next threat to U.S. manufacturers’ profits.

If the euro remains near its current low level of about $1.20 through the rest of the year, it could weigh down full-year results by several cents a share, executives from 3M Co (MMM.N: ) and Honeywell International Inc (HON.N: ) said.

That is serving to undercut some of the sector’s confidence over recently rising order rates, which had plunged during the recession and remained weak at the start of the year.

At a meeting with investors on Tuesday, a top executive at United Technologies Corp (UTX.N: ) spent a half hour explaining how orders for elevators and air conditioners were rebounding, but would go no further than to say the blue-chip company was “confident” it would make its full-year profit target.

The reason for his caution? The euro.

“Without the euro, I would be having a different conversation with you right now,” said Ari Bousbib, who oversees United Tech operations including Otis elevators, Carrier air conditioners and its fire and security products.

When the company set out its full-year guidance in December, it presumed the euro would trade at about $1.48 this year. Its decline means that the company’s European profits will be worth less when they are translated into dollars.

The euro headwind will primarily be felt in the second half, Bousbib said.

“We have the second-half headwinds and it will offset some of that goodness, if you will, from the first half,” he told a conference sponsored by JPMorgan. “Overall, we think that it will balance and we will meet guidance.”

That growing worry has contributed to the recent selling in industrial shares, which have fallen faster than the market as a whole during the recent correction.

The Standard & Poor’s 500 (.SPX: ) has retreated about 12 percent from its most recent April 26 high, while the S&P capital goods industry index (.GSPIC: ) is down 16 percent. Still, industrials have outperformed the broader market over the past year.

“This is a bit of an overreaction directly tied to the euro, but a portion of it is that the market did really well until the end of April, so it’s natural that we’d have somewhat of a pullback,” said Tom Villalta of the Jones Villalta Funds, which owns shares of industrials including General Electric Co (GE.N: ) and Caterpillar Inc (CAT.N: ), but prefers technology and financial names right now.

HIDING BEHIND THE HEDGES

Investors are now getting a sense of how much a hit to earnings the currency’s weakness could mean.

“With the euro weakening the way it has, we probably have a nickel or so of downside in the back half of the year versus where we were, our guidance, at the end of the first quarter,” Pat Campbell, chief financial officer at 3M Co (MMM.N: ), told the same conference where Bousbib spoke.

The maker of products ranging from Post-It notes to films for flat-panel displays looks for 2010 earnings of $5.40 to $5.50 per share. In the short term it will be able to use currency hedges to offset some of the effects of the slump, which could take a heavier toll on profit if it lingers.

“It’s partially muted in the short term,” Campbell said. “You don’t get the full impact on the short-term basis.”

Another factor tempering executives’ concern is that European demand has not begun to slump, at least yet.

“There’s no indication of orders softening in Europe,” said Dave Anderson, chief financial officer at Honeywell. “We’re obviously monitoring that closely.”

The world’s biggest maker of cockpit electronics initially presumed the euro would trade at about $1.35 this year, though by April it had lowered its assumption to $1.25. If the euro remains around $1.20 through the second half of the year, it could reduce earnings by 4 cents per share, while a slide to $1.15 would mean a 5-cent-per-share drag, Anderson said.

Honeywell looks for 2010 profit of $2.30 to $2.45 a share.

A quarterly survey by the PricewaterhouseCoopers (PWC.UL: ) consultancy found just 18 percent of chief executives and chief financial officers at 255 privately held companies identified foreign exchange as a barrier to growth. That is unchanged from the prior quarter, and down from 19 percent a year ago.

In the short term, currency troubles could be an easy excuse for companies that miss their numbers, but in the longer term it could be a sign of a weakening European economy that would be a more substantial challenge for industrials, investors said.

“Companies that are seeing a slowdown for fundamental reasons can always blame the currency,” said Keith Goddard, president of Capital Advisors in Tulsa, Oklahoma. “Big industrial companies that compete with German manufacturers, for example, definitely will feel some pressure.”

Europe’s debt crisis is a symptom of a wider problem, Goddard said. Markets are forcing developed economies to cut debt. In 2009, investors perceived that Dubai’s debt problems were a one-off event and developed country debt could be addressed once economies recovered. That luxury is gone.

“The markets are forcing change,” Goddard said. “There is absolutely no way to get fiscal positions closer to balance in the developed world without a drag on growth.”

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(Reporting by Scott Malone and Nick Zieminski; Editing by Tim Dobbyn)

Analysis: Sliding euro is U.S. manufacturers next big worry