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Analysis: European Earnings Face a Low Bar, but Investor Patience Wears Thin


LONDON, July 28 (Reuters) – European stocks may manage to emerge from this earnings season in the black, despite China’s faltering economy and persistent global inflation, as expectations are so low that investors are likely to warmly welcome any positive surprises.

But there are fewer of those than usual. About a sixth of the European STOXX 600 index (.STOXX) has reported earnings and so far less than half of them have beaten expectations, fewer than in a typical quarter. Not only that, shareholders are severely punishing any misses in a sign the market’s tolerance for meagre results is running low.

The European index has risen 9% this year, but most of those gains came in the first quarter of 2023, when investors were optimistic about China’s post-COVID reopening and relieved that Europe would likely avoid recession.

Since then, Chinese growth has lost momentum, which has raised concern how European companies exposed to the world’s second-biggest economy would fare while already dealing with persistent global price pressures and rising borrowing costs.

As a result, the bar for beats is low, said Axelle Pinon, a member of the investment committee at asset manager Carmignac.

“Since the beginning of the year, (equity valuation) expansion has been more limited in Europe, compared to the U.S,” Pinon said. “Consequently, fewer upward revisions in earnings projections are needed to support the ongoing market rally.”

The STOXX 600 is currently trading at a PE ratio of 15.66, compared with a ratio of 24.9 for S&P 500 (.SPX), its largest discount in at least 24 years, according to Refinitiv Datastream.

Analysts have cut earnings forecasts for MSCI Europe companies since June 23, the longest such stretch of downward revisions since the outbreak of the Ukraine war last February.

In the second quarter, STOXX 600 company earnings are forecast to drop 8.1% year-on-year, a small improvement from last week’s forecast 9.2% drop, but still marking the worst quarter for corporate results since 2020, according to Refinitiv I/B/E/S data.

But there has been some bright spots in the quarter. French carmaker Renault (RENA.PA) reported strong global car sales and Unilever (ULVR.L), the maker of Dove soap and Ben & Jerry’s ice cream, topped forecasts after successfully pushing through another round of price increases.

“We’re actually looking possibly for upside surprise in what is (expected) to be a pretty slow and negative quarter,” said Kleinwort Hambros Chief Investment Officer Fahad Kamal, adding that the Chinese and European economies are still showing signs of resilience.

“I’m pretty bullish on Europe, to be honest. There’s job growth, there’s wage growth, the consumer remains probably reasonably well anchored,” he added.

HARSH PUNISHMENT

So far this season, any companies that have missed earnings expectations have been punished harder by investors than at any point in the last five years, according to Bank of America.

The current European earnings season is showing the weakest beat ratio since late 2019, according to BofA, which notes earnings-per-share misses resulted in a median one-day underperformance of 2%, the biggest negative reaction since the final quarter of 2017.

One fifth of Electrolux (ELUXb.ST) market value was wiped out last week when Europe’s biggest home appliances maker reported a second-quarter loss.

And even beating expectations may not be enough right now.

LVMH (LVMH.PA), Europe’s most valuable company, lost 5% of its market value on Wednesday after it reported an increase in sales that matched expectations, but offered a less upbeat forecast.

Beyond the second quarter, the outlook is rather gloomy.

While so far customers have generally been able to stomach higher prices, it is unclear how much a potential consumer squeeze could hit margins, Carmignac’s Pinon said.

“The key question going forward is how disinflation and an economic slowdown will impact spending, along with the risk of price wars developing,” Pinon said.

The forward 12-month net profit margin for the STOXX 600 is 9.9%, down from an all-time high of 10.1% in November 2022, according to Refinitiv Datastream.

Ben Jones, director of macro research at Invesco, said earnings beats will be harder to come by this quarter and inflation will likely start eating into profit margins.

“We’d look for that to get worse as the consumer squeeze deepens through 2023,” he said.

Source: Reuters

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