Here’s Why Devaluation of the Venezuelan Bolivar is a Big Deal for P&G
Last week, Venezuela partially moved to a free-floating currency platform named Simadi, without discarding currency controls for certain transactions.  The troubled Latin American country now has a three-tiered currency system comprising of a preferential rate (CENCOEX), a complimentary rate (Sicad) and the new floating rate (Simadi). The good news is that the restrictions over buying and selling dollars by corporations will be lifted by using the floating exchange rate. The bad news is that the value of dollar-denominated assets will be wiped out if transacted at the market-determined rate.
This puts global consumer products powerhouse Procter & Gamble (NYSE: PG), which has substantial exposure to Venezuela, in a precarious situation. As of December 31st, 2014, it had Bolivar-denominated assets worth a little over $1 billion, more than half of which it had valued at the preferential CENCOEX rate of 6.3 Bolivars per USD.  The remaining assets had been valued at the Sicad rate of about 12 Bolivars per USD but are now likely to be valued at the new floating rate. Given that the floating exchange rate recently opened at 170 Bolivars per USD,  the vast gap between the two rates will result in a significant write-down upon revaluation of the assets.
In this report, we will delve into how the unfolding Venezuelan currency crises will impact Procter & Gamble.
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The Venezuelan Currency Paradigm
The introduction of the floating exchange rate system adds a further dimension to the already complicated Venezuelan currency scheme. Instead of adopting a fully market-controlled mechanism, the government has chosen to continue unsustainable currency controls alongside the floating exchange rate mechanism.
Now, the preferential CENCOEX rate of 6.3 Bolivars per USD will continue be used for essential items like food and medicines. The Sicad rate will be used for less critical items like travel and luxury goods and will start from 12 Bolivars per USD. The Simadi floating rate will be determined by demand and supply factors, and it promptly skyrocketed to 170 Bolivars per USD at opening.  The spread between the government-controlled CENCOEX rate and the market rate stands at a stunning 163.7 Bolivars per USD. According to P&G, a significant portion of its imports into Venezuela so far were being made at the preferential CENCOEX rate. ((P&G 2015 second quarter SEC filings))
Currency Devaluation May Wipe Out 40% of the Value of P&G’s Venezuelan Assets
P&G’s total assets denominated in the Venezuelan local currency were valued at $1.06 billion as of December 31st, 2014. Of this, the company has stated that assets worth $600 million are earmarked to be utilized for settlement of liabilities pertaining to transactions falling under the preferential CENCOEX rate. Therefore, these were valued using the rate of 6.3 Bolivars per USD. The remaining $460 million worth of assets were valued at the erstwhile SICAD-I rate of about 12 Bolivars per USD. It is this second tranche of assets that are liable to be revalued following the devaluation of Bolivar.
The value of this second tranche of assets, calculated on the basis of the floating rate of 170 Bolivars per USD, comes to just $31 million. Thus, value of about $429 million, which is over 40% of P&G’s total Venezuelan assets, will get wiped out instantly due to the steep currency devaluation. The potential write-down of $429 million will pull down EPS by about $0.16 (based on 2.7 billion shares outstanding as on December 31st, 2014).
The above calculation assumes that P&G is able to utilize the first tranche of assets worth $600 million at the CENCOEX rate of 6.3 Bolivars per USD. Given the ongoing economic turmoil and unpredictable policy regime in Venezuela, the company has admitted that even the first tranche of assets is not immune to revaluation. The Venezuelan government may decide to devalue the CENCOEX rate in the future, or the company may not be able to settle its liabilities at that rate, or may not be able to obtain sufficient amount of dollars at that rate due to limited availability. In such a case, the extent of write-down of P&G’s Venezuelan assets may be considerably more than $429 million.
Sales and Margins May Also Take a Hit
Even prior to the currency devaluation, Venezuela was suffering from acute shortage of necessary products amidst a debilitating inflation. Now, the sharp devaluation of the Bolivar will inevitably result in higher commodity prices and lower spending capacity. These factors are likely to result in a sharp drop in P&G’s sales volumes in the region.
Government-imposed pricing controls and import restrictions also continue to remain in place, which will hurt P&G’s ability to counter higher commodity costs by raising prices. Perhaps more importantly, the company has stated that going forward, certain finished goods and raw materials, along with payment of dividend and royalties, will be executed under the Sicad rate rather than the CENCOEX rate. This is expected to push additional foreign exchange pressure on the company’s margins. The combination of these factors is likely to cause a severe hit to P&G’s margins in the region.
While Latin America accounts for 10% of P&G’s total revenues, the company does not disclose what proportion of sales it derives from Venezuela alone. However, given that the region includes other major markets like Brazil and Argentina, we believe that Venezuela’s revenue share may not be big enough to have a drastic impact on overall growth rates and margins. Therefore, we believe that the bulk of the financial impact of the currency devaluation will be in the form of a write-down of the local-currency denominated assets.
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- Venezuela Revises Foreign Exchange Rules, Wall Street Journal, February 10, 2015 [↩]
- P&G 2015 second quarter SEC filings [↩]
- Venezuela’s new forex system opens at 170 bolivars to dollar, Reuters, February 12, 2015 [↩] [↩]