This article first appeared in The Edge Malaysia Weekly on October 31, 2022 - November 6, 2022

WITH the US Dollar Index rising to a 22-year high, a number of Malaysian companies are feeling the pinch from their exposure to US dollar-denominated debt. For some, it is a double whammy with losses in recent quarters as they also have exposure to emerging economies.

Previously deemed areas of growth, markets from Thailand to Sri Lanka became a drag as the impact of the very strong US dollar was compounded by weakening local currencies — some more than the ringgit’s 13% decline this year against the greenback.

In crisis-hit Sri Lanka, where Axiata Group Bhd operates the country’s leading telco Dialog Axiata plc, the 81% drop in the Sri Lankan rupee this year is the main culprit behind the telecommunication group’s unrealised foreign exchange (forex) loss of RM950 million in the six months ended June 30 (1HFY2022). The group has booked two consecutive quarters of losses as a result.

Aviation group Capital A Bhd, which has an effective stake of 45.12% in Thai Air Asia Co Ltd, booked a forex loss of RM398 million in 1HFY2022, partly because the baht slipped nearly 6% against the US dollar during the period (now down by nearly 14%). Despite posting its strongest quarterly revenue since the pandemic of RM1.47 billion in 2QFY2022, the group’s net loss of RM931.2 million in the quarter was also the worst since 4Q2020.

Companies with US dollar liabilities book forex losses when the greenback strengthens as they anticipate using more of the local currency to pay off the principal and interest when it comes due, and vice versa.

The situation will also affect companies that import content to sell in the domestic market. This includes those in sectors such as textile finishing, electricity and gas, and construction, according to data provided by the Department of Statistics Malaysia. Additionally, companies selling in emerging economies with weakening currencies will be affected.

For example, investors worried about this situation sold down their shares in Astro Holdings Bhd, sending the counter to 65 sen, the lowest since the pandemic, given the pay-TV operator’s US dollar exposure to as much as 50% of its content cost and 40% of its debt. A recent decline in subscription revenue also affected investor sentiment.

To be sure, local companies have kept their US dollar borrowings low since the 1997/98 Asian financial crisis. Malaysian companies’ US dollar-denominated private sector debt amounted to about 11% of GDP as at 4Q2020, according to data provided by the International Institute of Finance. Past reports showed that many companies generally borrow at fixed rates, thus hedging against a rising interest rate environment.

Furthermore, the companies’ exposure to emerging markets has been in the making for years, giving them ample time to prepare through different hedging mechanisms.

When contacted by The Edge, Axiata says its Sri Lankan operation has been executing initiatives that eliminate forex exposure, maximise US dollar revenue and localise business to manage the US dollar liquidity situation, on top of digitalisation and cost rationalisation.

“All these efforts are delivering results and we are cautiously optimistic that the worst is now behind us. There are no plans to exit Sri Lanka as the current situation is a temporary one, which we are closely monitoring and proactively managing,” it adds.

Of Axiata’s RM20.84 billion in borrowings, 55% are at fixed rates. The telecoms operator hedges about 43% of its US dollar debt of RM13.17 billion (as at end-June), although it should be noted that the group took on another US$150 million loan in July, to be used as working capital for network capacity expansion in Sri Lanka.

Axiata points to Dialog Axiata’s strong fundamentals such as how its revenue ex-device has increased 20.3% year to date. It attributed this to higher contributions from all segments.

It is a different story for Capital A as the aviation industry has yet to fully recover to pre-pandemic levels. At end-June, the group had no outstanding amount for forward forex contracts. Its US dollar debt stood at RM1.56 billion, or 56.39% of its borrowings of RM2.77 billion.

In Astro’s case, CGS-CIMB suggests in a report that the free cash flow of the dividend stock may not be severely strained in this current environment. The research house assumes a content cost-to-TV revenue ratio of 37% to 38%, as opposed to 35% to 37% over the years. In 2QFY2023, content cost stood at RM268 million, or 32% of TV revenue, Astro’s data showed.

“For some agreements, Astro has a clause that stipulates the content owners bear exchange losses if the ringgit drops to a certain level. With past US dollar borrowings swapped to ringgit, it is likely that the remaining borrowing of US$333.1 million is slated for conversion as well,” says CGS-CIMB.

Interestingly, two companies with significant operations in hyperinflation-hit Turkey — IHH Healthcare Bhd and Malaysia Airports Holdings Bhd (MAHB) — have managed to deal with the impact of the 29% decline of the lira this year.

IHH, whose operations in Turkey contribute about 20% of its bottom line, posted a record quarterly net profit of RM612.1 million in 2QFY2022. For 1HFY2022, its operations in Turkey and Europe, parked under Acibadem, posted a profit before tax of RM435.5 million, or 29% of the group’s total of RM1.5 billion.

Meanwhile, MAHB, which typically derives 25% of its revenue from Turkey, where it operates one of two international airports in Istanbul, posted its fourth consecutive quarter of narrowing loss in 2QFY2022.

For MAHB, its overseas airport services segment posted a profit before tax of RM27.96 million in 1HFY2022, with 13.84 million passengers recorded at its Istanbul Sabiha Gökçen International Airport (SGIA), as opposed to the loss-making Malaysian airport operations during the period. In 3Q2022, SGIA recorded 9.03 million passengers, not far from the 9.91 million passengers recorded in 3Q2019.

The direct impact from the plunge in the lira has been minimal. That is because IHH and MAHB’s earnings in Turkey are mostly denominated in the euro. Furthermore, they do not have US dollar borrowings on their books but in the euro instead — which has strengthened 0.86% against the ringgit this year.

IHH says in an email reply, “We have been actively diversifying the revenue base for Acibadem [Healthcare Group] over the past few years, which has provided us additional resilience. Foreign patient numbers for Turkey have already surpassed pre-Covid levels. Non-lira contributions now comprise nearly half of Acibadem’s revenue (46%). These are predominantly euro-denominated and serve as a natural hedge to the lira.

“While there will be adjustments to be made with the application of the MFRS 129 financial reporting standard (for hyperinflationary accounting), we are confident of the growth trajectory for not only Turkey but all our European operations and remain fully committed to the region.”

MFRS refers to the Malaysian Financial Reporting Standards. The MFRS Framework comprises standards issued by the International Accounting Standards Board.

Separately, Tenaga Nasional Bhd’s 30%-owned power unit Gama Enerji AS in Turkey is Ebitda (earnings before interest, taxes, depreciation and amortisation) positive this year, thanks to the surge in electricity prices to all-time highs.

“Furthermore, some portions of Gama’s revenue and cost are indexed to the US dollar, and this cushions the financial impact of the hyperinflation and provides steady cash flows. There is no additional capital injection required at the moment,” Tenaga tells The Edge in an email reply.

Meanwhile, Laos has seen its currency fall 54% against the US dollar this year and high inflation that hit 34% year on year in September.

Mega First Corp Bhd, which operates the Don Sahong hydro plant, was shielded from the impact as its revenue collection and functional currency is the US dollar. It also provided a natural hedge to its US dollar borrowings, which amounted to RM502.51 million, or 64.4% of its total borrowings of RM779.62 million.

“We do not expect Laos’ weak fiscal position, relatively high public debt and low foreign exchange reserves to significantly affect Don Sahong’s trade receivable collection from [its client] EDL ( Électricité du Laos),” Mega First said in its latest results report.

Meanwhile, will the US dollar continue its upward trajectory?

Headwinds from a rising greenback will continue to persist as the US Federal Reserve’s monetary tightening does not appear to be over. Amid stubborn US inflation and a strong jobs market, economists polled by Bloomberg estimate another hike of 75 basis points (bps) in the US Fed funds rate in November to 3.75%-4%, and potentially another 50bps increase in December.

The ringgit’s slide accelerated in the last two months, down 5.3% against the US dollar to levels above 4.71 — not far from its record low of 4.88. The US Dollar Index, trading at 109 points, is quite near its September peak of 115 points.

“The ringgit’s sharp decline against the US dollar is expected to stabilise and retrace its value once the US monetary tightening subsides. This is expected to occur over the next six to nine months when the high inflation is brought under control amid the continuing slowdown and increasing recession risk enveloping the US economy,” says Dr Yeah Kim Leng, professor of economics at Sunway University Business School.

While inflation is expected to slow in 2023, companies may still face the challenge of adjusting prices upwards to catch up — with 4Q2022 inflation seen at 3.6% in Malaysia, 6.6% in Thailand, 65.5% in Sri Lanka and a whopping 80% in Turkey in 4Q2022, Bloomberg forecasts show.

Exposure to emerging markets with unfavourable economic circumstances will add further stress to affected companies, says Malaysian Institute of Economic Research (MIER) senior research fellow Dr Shankaran Nambiar. “They will have to withstand defaults in payment, supply bottlenecks and collapsing demand.

“The pressure due to the cost of imported intermediate products will be worsened due to inflationary pressures, compounded by forex exposure. Naturally, [this leads] to forex losses, which have to be borne so as not to lose orders.”

IHH says that at the moment, demand has been so strong that the group recently commissioned a new hospital, Acibadem Ataehir (280 beds), and acquired Ortopedia Hospital (52 beds) to serve even more patients in the country. The group will seek and capture both organic and inorganic opportunities in the region, it adds.

Axiata says the Sri Lankan telecoms industry was able to raise prices by 20% to 25% in both the mobile and fixed-line segments.

However, lessons may be learnt from Tenaga, which has already written down its Gama investment — acquired in 2016 for US$255 million — in 2018 amid adverse macroeconomic conditions in the country.

Naturally, Sri Lanka is the next economy of concern. Some analysts suggest that Axiata’s earnings will continue to be dragged down for another year due to the forex issues it is facing. Apart from Axiata, Carlsberg Brewery Malaysia Bhd also has exposure there through its 25%-owned Lion Brewery (Ceylon) plc.

Axiata, in its reply, says Dialog Axiata — which analysts say represents 8% of the group’s sum-of-parts valuation — should be valued as an ongoing concern, although at a substantially lower multiple and/or higher discounted rate. “Unlike Turkey, the accounting treatment in Sri Lanka is not based on International Accounting Standard (IAS) 29, that is, financial reporting in hyperinflationary economies,” it adds.

The International Monetary Fund’s (IMF) World Economic Outlook this month forecast inflation in Sri Lanka to reach 94% over the three years ending 2022.

“The IMF expects the three-year cumulative rate of inflation to reach 107% in 2023, in which case inflation accounting would be required. So, companies should really be monitoring Sri Lanka for hyperinflation,” says Pieter Dekker, partner, Professional Practice Group, Ernst & Young Accountants LLP.

“My sense is that we will have to see a worsening of circumstances going into 2023,” says MIER’s Shankaran. “The situation will get worse even if the US manages to cut the inflation rate and pays for it with a shrinking economy. Under that scenario, we will see a tougher US dollar alongside reduced demand — certainly an unfavourable set of circumstances.”

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