The right FX exposure - what Unilever and Wolseley might be telling us

I briefly looked at Unilever last a couple of months ago and was impressed with their price-mix progression:


Late yesterday, the company updated the market with this comment:

'Unilever will say that it has seen weakening in the market growth of many emerging countries in quarter three and now expects underlying sales growth of 3 to 3.5% in the quarter. The emerging market slow-down has accelerated as a result of significant currency weakening. Developed markets remain flat to down'.

Well using the above chart, currency weakness has been an issue for a little while.  The new element is a weakening in the emerging markets from the 5% growth level noted above.  This is a theme that will continue throughout the Q3 reporting period (and is also why I currently am struggling to find value in consumer staples/goods companies, as per this brand piece yesterday). 

The better news is that over time the emerging markets not only grow faster but ultimately - probably - have undervalued currencies (at least via the Big Mac index):

So what to do about Unilever?  Well the share price has sagged to one year lows as shown below. 

And as for valuation...the share trades in the mid x13s EV/ebit FY13e.  To get close to that x12 forward EV/ebit number we are looking for in peers such as Kellogg's or Coca-Cola this suggests below £22.  I note from the chart above, that at around the current share price there is some resistance, so I believe the actual Q3 numbers (and especially the tone of the comments) will be influential.  Currently I stay on the sidelines with the company. 

Whilst Unilever has its FX-related issues, the UK-listed plumbing and related building supplies business Wolseley had the opposite problem when it declared its final results this morning:

'The highlight of these results was another strong performance across our US business where we achieved good revenue growth and the trading margin of 7.3 per cent was ahead of the previous peak achieved in 2007'.

If we look at Wolseley's geographic business split, we can see the reason why they have done well.  The business is very US-centric:

Now, the main influence has undoubtedly been the better dynamism of the US business cycle versus - for example - the European one (described by the company as 'very challenging') but a stronger US Dollar also helped from a translation basis.

Here's the interesting observation though.  Since the end of July when the Wolseley results were finalised, the US Dollar (as represented by the DXY, the trade weighted US Dollar index, below) has fallen sharply:

Now, my call is that the US Dollar probably rises from here, but the scope for some Q3 results translation surprises from the US may exist. 

Wolseley interestingly trades on a similar multiple to Unilever and despite a 3.4% odd special dividend today (their balance sheet is ungeared) that is a full valuation. 

So the moral of the above?  FX exposure does matter.  The trouble is, we live in a confused world where everyone appears to want a lower exchange rate - therefore this theme is volatility adding for equities.  The next big call on the FX front is probably a lower Euro vs the US Dollar as economic reality (recall Wolseley's words 'very challenging') hit home.