Multinational profits hit hard by Canadian operations

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Deutsche Bank analyst John Inch is warning clients that the Canadian economy could drag profits lower for global industrial companies.

In a research report published Wednesday, Mr. Inch writes, "there appears to be increasing trepidation that Canada, which is America's largest trading partner, could be in for a much steeper correction in the months ahead … Canada is already starting to drag multi-industry companies in a big way. For instance [on Tuesday], Emerson reported ... organic sales growth in Canada [for the quarter ended Dec. 31] was down a striking 18 per cent."

The analyst goes on to note that for global industrial companies, revenue from Canada accounts for an average of 9 per cent of revenue and 10 per cent of profits. He strongly suggests these profits are at risk for Univar, W.W. Grainger, Dover, Illinois Tool Works, Parker Hannifin and Rockwell Automation.

Canadian investors aren't accustomed to thinking from this perspective – the effects of the loonie on revenues for foreign corporations – for good reason. For economists, however, the issue of Canada's attractiveness as an investment destination for foreign capital is an extremely significant consideration.

The declining profits for global industrial firms already operating in Canada won't encourage further foreign investment from them, but the weaker loonie provides a silver lining that, for patient companies, will offset the damage.

As Lowe Co.'s recent bid for Rona Inc. highlights, the cost of buying existing Canadian operations is becoming extremely attractive for foreign buyers. In Canadian dollar terms, the $3.2-billion bid for Rona is a 77 per cent increase over the $1.8-billion Lowe's offered for the company in 2014. But in U.S. dollars, which Lowe's cares a lot more about, the new price is only 38 per cent higher. The falling loonie makes Canadian companies far cheaper to buy than just 18 months ago.

The loonie has dropped 30 per cent since the peak in September, 2012, and Scotia currency strategist Shaun Osborne, among others, believes the majority of the currency's decline is behind us. Relative stability in the loonie – a welcome event for foreign companies already operating here – leaves the economic outlook as the most important driver of foreign investment.

Multinational companies will likely be watching closely when fourth quarter Canadian gross domestic product growth is reported on March 1. The consensus growth estimate has been falling rapidly and hard in recent weeks. In November, economists expected an annualized growth rate of 2 per cent for the final four months of 2015, but that estimate has now been slashed to 0.7 per cent.

Recent data for Canada – notably rising new orders for exported goods – have shown signs that the weaker loonie is bearing economic fruit in the manufacturing sector. If confirmed by a strong GDP result, this could provide global investors with the best of both worlds – a recovering economy where a weak currency makes it cheap to invest.