European Earnings Sapped by Strong Euro -- Update

The strong euro is taking a bite out of European earnings, with the region's companies bracing for more pain in the coming months and searching for ways to protect their bottom line.

On Wednesday, Inditex SA, the Spanish company that owns Zara, reported first-half results that indicated net income rose 1.5% in the second quarter, a modest increase for a company that booked 18% profit growth in the first quarter. Inditex's gross margin fell in the second quarter more than analysts had expected. Part of that decline was due to the impact of currency fluctuations.

The strong run of the European Union's single currency against the dollar and a host of other currencies since April has surprised many executives. The euro has risen 12% against the dollar since early April, trading Wednesday at $1.20.

With the European economy reporting solid growth, many analysts are forecasting continued strength for the euro in the coming months. At the same time, some expect the dollar to fall further amid expectations the U.S. Federal Reserve -- which wraps up a two-day policy meeting on Wednesday -- will slow down its pace of interest-rate increases.

Inditex, the world's biggest retailer and one of the best-performing, is particularly susceptible to swings in the value of the euro. The company's model of making many products in Portugal and Spain, where it has also based various brand headquarters and logistics facilities, gives it a major edge over rivals because of the speed with which new products hit Zara and other stores.

But that strategy brings headwinds when the euro strengthens. A stronger euro means higher costs while revenue generated in non-euro currency countries declines when translated back to euros. Inditex generates around 55% of sales in non-euro currencies with about 10% of the total coming from the U.S. and countries with currencies linked to the dollar.

The strong appreciation of the euro affected the gross margin in the first half of the year, Inditex Chairman and Chief Executive Pablo Isla said Wednesday, as did a commercial decision to get an early start to the autumn season.

Société Générale estimates that when currency fluctuations push Inditex's revenue down 1%, that wipes about 5 percentage points off of operating profit growth. Inditex's stock has fallen more than 10% since the beginning of June.

The U.K.'s Diageo PLC, the world's largest spirits company, on the other hand, has benefited from the strength of the dollar against the pound -- which is down 9% against the greenback since the U.K. voted to leave the European Union -- because 40% of its operating profit comes from North America.

Similarly, Italian drinks company Davide Campari-Milano SpA reported strong earnings early in the year, reaping the benefits of heavy investments over the past couple of years in the U.S. market, which has grown more strongly than Europe.

The strong dollar helped goose Campari's results late last year, but now the Milan-based group will suffer the currency gyrations. "I had some of the most eminent investments banks telling me at the beginning of the year that we'd be going to parity," said Campari CEO Bob Kunze-Concewitz in an interview. "That's when the euro was at about $1.05."

Airbus SE, the world's No. 2 plane maker after Boeing Co., is also highly sensitive to long-term swings in the euro-dollar exchange rate because it has orders for aircraft that it will deliver several years down the line. While the company sells its planes in dollars, it has most of its costs in euros because its main factories are in France and Germany.

When the euro strengthens 1 cent against the dollar, it depresses Airbus earnings by more than EUR100 million ($119.9 million). To insulate itself against the impact, Airbus uses currency hedges that lock in exchange rates for several years, much longer than most companies that hedge.

For auto makers, which source parts and produce their cars in many different countries, foreign exchange is the largest determinant of their profitability after volume, and the euro's rise could become a problem by year's end, according to wealth manager Bernstein. If the euro stays above $1.20 for a sustained period, earnings estimates for the car makers, most of which are likely hedged through until early 2018, will have to be trimmed, said the wealth manager.

Royal Ahold Delhaize NV, the Dutch food retailer with more than 60% of its earnings coming from the U.S., is looking to mitigate the recent dollar weakness so it can protect earnings and deliver on the EUR500 million it promised as part of last year's mega-merger between Ahold and Delhaize.

"Clearly (the strong euro) puts us under a little bit more pressure," said Ahold Delhaize CFO Jeff Carr last month. "Obviously we do what we can to adjust the small effects, but when we see an exchange rate move from $1.08 to $1.18 (forecasts will have to be adjusted)."

--Robert Wall, William Boston and Saabira Chaudhuri contributed to this article.

Write to Eric Sylvers at eric.sylvers@wsj.com and Jeannette Neumann at jeannette.neumann@wsj.com

(END) Dow Jones Newswires

September 20, 2017 14:30 ET (18:30 GMT)