Fight back against Australian dollar volatility

As the Australian dollar rises the cost of imported goods becomes cheaper. Conversely, a depreciation in the AUD will make imports more expensive.

The dilemma facing most Australian businesses, who import goods or components, is how to take advantage of the current high AUD. Whilst imported goods should be cheaper now than at any time post float, currency volatility still exists and the cash flow impact of this volatility continues to be felt.

The profile below offers an insight into how an importer was able to minimise their exposure to exchange rate movement and protect their NPAT (Net Profit After Tax) margin.

The client is a retailer of recreational boats.

They predominately sell an Australian manufactured brand, but the client became aware of a New Zealand manufactured boat that had outstanding rough water capability, and saw a local market for this craft. However our client would need to import the boats directly.

The client negotiated the terms with the supplier as 30% deposit on order and then the balance at shipping time, which could be up to 3 months after the order is placed.

The client sought our advice on purchasing and paying away the NZD. We also brought attention to the fact that they are going to have an exchange rate risk with respect to the balance of the payment due at the time of shipping, some 3 months after ordering.

The range for the AUD/NZD since Jan 2011 has been >10cents (1.2760 – 1.3794).

To enable them to address this risk, we had to determine where the risk lies, and what tolerance the business has for this risk.

The client wants a 25% margin on the cost of the craft.
Each boat cost NZD50,000 and the cost to bring the boat to saleable spec (outboard, safety equipment, shipping, sales & admin costs) is AUD25,000.

The boat is ordered when AUD/NZD exchange rate is 1.31, meaning the AUD cost of a NZD50,000 boat is $38,200 plus costs of $25,000, the cost price of the craft is now $63,200. The boat will sell for $79,000.

What the client needed to consider was a depreciation of the AUD against the NZD between time of order and time of shipping. Consider the impact of a 1.26 exchange rate when purchasing the final NZD.
The cost of the boat would be deposit NZD15,000 @ 1.31 + balance NZD35,000 @ 1.26 making the cost now $39,250, add $25,000 the cost price is now $64,250. To maintain 25% margin the sale price needs to be $80,300.

The increase in sale price needs to be passed on to the buyer of the boat, no issue unless however our client had agreed to a fixed price with the buyer, then our client’s margin is compromised.

The fix: We suggested our client use currency options to protect the exposure. In this case an AUD put/NZD call was employed.

Our client decided that a exchange rate of 1.30 on the NZD35,000 in 3 months time would be tolerable, for this to be guaranteed a premium ofAUD900 would be payable. The result of this would mean a cost price of NZD15,000 @ 1.31 + NZD35,000@ no worse than 1.30 + AUD900 premium, giving a worst case cost of $39,300 + $25000, therefore a cost price of $64,300, meaning a sale price of $80,375.

While this end price is higher than the original price, the benefit for our client is that they have a worst case cost to work to, and the beauty of the exchange rate protection using the option is that they will benefit from any appreciation in the AUD/NZD exchange rate, meaning margin, and therefore profit will be higher or there is the ability to offer a discount to the buyer.

If you think your business could benefit from speaking to a Global Market’s specialist please give your local ANZ banker or Foreign Exchange Manager a call to discuss your specific business needs.

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