3 Ways to Profit from a Weak Euro

07/27/2012 9:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

To make money even while the euro struggles, take a look at best-in-class European exporters. Here are three stocks worthy of investors' attention, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

"Nibble, nibble, little mouse, who is nibbling at my house?"

Nope. Not Hansel. Not Gretel. I'm starting to nibble at the shares of euro exporters.

I don't think I can call a bottom in the euro—$1.20? $1.14? Parity? And I am very certain that we're not going to witness anything like the end of the Euro debt crisis in the next few weeks. But I think odds are tilted enough in favor of euro exporters that it's time to start buying initial positions in the best-in-class companies.

In fact, my logic here doesn't depend on an end of the Euro debt crisis, or a quick recovery in the euro at all. I wouldn't mind seeing the euro continue to stumble even after I've made my buys.

You see, that's what I'm counting on.

Currency Math
A continuing Euro debt crisis works in favor of the stocks of euro exporters by reducing the prices that customers who buy in dollars, yuan, yen, pesos, or reais pay.

That means the decline in the euro, from $1.44 on July 26, 2011 to $1.21 on July 25, has made anything priced in euros almost 16% cheaper for anyone paying in dollars. That same trend has been at work for anyone paying in most of the world's currencies.

The Euro debt crisis has been an equivalent of a 16% sale. And we all know what a sale can do for demand—especially if a company is selling against competitors who aren't giving customers a similar price cut from a falling currency.

The Euro debt crisis also works to inflate the revenue—and thus the earnings—of any company that collects dollars or yen or yuan from its customers and then translates those currencies back into euros on its income statement.

Think of this as the flip side of a problem faced by McDonald's (MCD) and other US-based, dollar-using companies. McDonald's has said that the strong dollar will cost it 21 cents or so in revenue per share in 2012. Well, euro exporters will pick up revenue per share as a result of the weak euro

If you're a dollar-based investor (or yen or reais or yuan), the Euro debt crisis has given you another boost: Your currency will buy more of a Eurozone exporter's stock than it would have a month ago.

It's not just that a weaker euro means you can buy more widgets with your US dollars. You can also buy a bigger hunk of a euro exporter. And that would be true even if the stock in question hadn't plunged in price—its euro price—because of the Euro debt crisis.

Some caveats:

  1. To take the biggest advantage of the effects of the Euro debt crisis, you've got to buy the shares of companies that are priced in euros (or euro-pegged currencies, such as the Swiss franc and the Danish krone) and that do business in euros. You won't get the same effect if you buy companies priced in the Norwegian krone or the Polish zloty.
  2. Pay attention to where a company sources its products. You lose much (or at least some) of the pricing edge from a falling euro if the company is paying a higher price to source its product in stronger non-euro currencies.

    Don't make assumptions here. For example, until I did some digging, I assumed that Spanish retailer Zara, owned by Inditex, must be doing most of its sourcing outside Europe. That would drive up the prices that the company has to pay for the clothing it sells.

    It turns out that about 50% of Zara's sourcing is from Spain and 26% from elsewhere in Europe—Portugal, for example. Zara will feel the full effect of the weaker euro when it sells in New York or Tokyo.
  3. The danger, of course, is that the Eurozone debt crisis will escalate in a way that takes down the share price of even the strongest euro exporter. That's why you want to nibble now rather than go all in, and why you want to buy shares of the best exporters.

    You're looking for exporters that are so good at what they do that trouble in their home markets will be outweighed by gains in export markets. For example, shares of Finnish elevator company Kone (KNEBV.FH in Helsinki), the fourth-largest elevator company in the world, are up 26.2% in the past 52 weeks.
  4. You're also betting that the global economy isn't about to head off a cliff. This play works only if you think that the US and Chinese economies will be relatively stronger in the second half of 2012. That's my read of the tea leaves. But if it isn't yours—if you think the US is headed back into recession and/or that China is headed for a hard landing—then these aren't buys for you.
  5. As hard as it is to identify the best-in-class euro exporters, once you've found them, it can be tough to buy them. Some of the best trade only in the stock markets of their home countries. I've tried to list some picks that sell in New York.

    Don't assume you can't buy one of these stocks if it trades only in its home market. Online brokers have vastly improved their foreign desks, and it never hurts to ask.

3 Stocks for Nibbling
Kone (KNEBV.FH in Helsinki): What's startling to me about Kone, the Finnish maker of escalators and elevators, isn't that the stock is up 26% in the past year during the Euro debt crisis, but that shares have climbed even as worries about growth in China have increased.

Sales from the Asia-Pacific region made up 27% of revenue in 2011, up from 17% in 2009. And Kone hasn't backed away from China: In May, the company doubled its ownership in its GiantKone joint venture.

What's helped Kone in China and during the Euro debt crisis is the way that sales of new elevators and escalators work in concert with maintenance contracts for that equipment. When sales of new equipment falter, revenue from maintenance on existing installations fills the gap.

Globally, Kone converts about 80% of its new orders into maintenance contracts, the company said in May. In China, the conversion rate is about 60%.

Kone doesn't seem to be having much trouble with new orders. On July 19, the company raised its guidance for 2012 to an operating profit of €760 million to €820 million ($933 million to $1 billion). Operating income for the second quarter rose to €208.5 million versus the consensus forecast of €200 million. Group revenue will climb by as much as 13% in 2012.

The stock sells at a trailing 12-month price-to-earnings ratio of 20.4, and pays a dividend of 2.77%.

Luxottica Group (LUX): You can see the effects of the Euro debt crisis on just about every line of Italian eyewear maker Luxottica's May 7 quarterly earnings report.

Net sales rose by 14.9% from the first quarter of 2011—or 11.1% at constant exchange rates that subtract the effect of the weak euro and the strong dollar. Net sales for the company's retail division, which includes the company's LensCrafters and Sunglass Hut chains, rose by 16%—or 10.1% at constant exchange rates.

The weak euro couldn't come at a better time for the company. Luxottica has just launched its line of Coach-branded eyewear. The initial stock sold out and the company projects going from $0 to $60 million in sales in the first year. And guess where Coach's (COH) brand is most powerful? In the strong-currency economies of the United States, Japan, and China.

And the company's growth has been so strong in emerging economies—36% year-over-year in the first quarter of 2012—that Luxottica isn't suffering too badly from getting just 6% growth in Europe (and 9% in the United States) in that quarter. Plus, in the Euro debt crisis, Luxottica gets to reap the benefits of manufacturing operations balanced between China and Italy.

The stock is up just 3.03% in the past 52 weeks. The shares trade at a multiple of 21.56 times projected 2012 earnings per share, and carry a 1.87% yield. (Luxottica is a member of my Jubak Picks 50 portfolio.)

Groupe Danone (DANOY), which also trades as BN.FP in Paris: The French seller of yogurt, bottled water, and baby foods has been pummeled by the Euro debt crisis.

The latest hit came on July 19, when the company said that falling yogurt sales in Spain and Southern Europe—as hard-pressed consumers switched to cheaper brands—would result in a 0.5-percentage-point drop in operating margin in 2012.

The shares of the New York-traded ADR have tumbled by 8.7% from the close on July 19 to the close on July 25. The stock is now down 21.9% in the past 52 weeks.

But Danone isn't just yogurt, and it's not just a European company anymore. The company's two biggest markets in 2011 were France and Russia, at 11% of revenue each. Spain and the United States come next at 7% of revenue each.

But 51% of Danone's sales now come from emerging markets (and 38% from Western Europe). Sales in Asia have grown at a compounded annual rate of 14.5% from 2008 to 2011. The company is the leading seller of bottled water in Asia, for example.

The ADRs trade at 15.07 times projected 2012 earnings per share, and pay a 3.17% dividend. (The dividend, paid once a year, was paid in May.)

I think these three nibbles are enough to get you started. There is still plenty of volatility ahead for investors in Europe, so don't eat too much now. You don't want to wind up in the oven with the witch, do you?

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of McDonald's as of the end of March. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

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