Peak profit means danger for European profit season

The pain is likely to subside quickly and hard for any European company that doesn’t make it through this earnings season.

At least that’s the early reading of a handful of names among those who have reported so far.

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Only online fashion retailer Asos Plc saw nearly a fifth of its market value wiped out in one day on Thursday due to weaker sales. Just Eat Takeaway.com and Siemens Gamesa Renewable Energy SA also collapsed after disappointing investors last week. A fall in sales from UK trench coat maker Burberry Group Plc on Friday wasn’t enough to impress investors and shares fell a whopping 5.2%.

It raises questions as to whether the bullish exuberance in the markets has reached a tipping point. Shares are already at record highs and expectations for European earnings growth have skyrocketed recently, with analysts at Goldman Sachs Group Inc. clocking the consensus rise since March as the largest in two decades.

“Any miss or cut in guidance is likely to be severely penalized,” said Julien Lafargue, chief market strategist at Barclays Private Bank. “After a very strong first quarter, expectations are high.”

That could limit the market’s reaction to earnings that have the highest forecasts, Morgan Stanley strategists including Ross MacDonald wrote in a note. A similar situation to the first quarter could emerge, they said, in which the underperformance of stocks that fell short of estimates was more significant than the outperformance of those that beat forecasts, they said.

On average, 16 companies per day from the benchmark Stoxx Europe will report 600 meters between now and the end of August, Goldman estimates. Amid that flood of filings, investors will be pinning for clues about the pace of reopening in the services sector, as well as profit margins and shareholder returns.

With the Covid-19 delta variant sweeping the world, there is nervousness as lockdown restrictions are lifted. At the same time, the tentative second-quarter reopening means services-oriented sectors such as travel and leisure could see favorable year-over-year comparisons, according to Cristina Benito, head of equities for discretionary portfolios at Mapfre AM.

Traders will want to watch for red flags on inflation. Companies such as Siemens Gamesa, which issued a profit warning on July 15 amid cost pressures from rising steel and commodity prices, are taking a hit.

“It will be those companies that are able to handle higher cost pressures, and those that see the strongest end-market demand that will do the best,” said Paul Morgan, an investment manager at Barings.

According to a State Street report, the media and food retailing sectors are among the most resilient to a price squeeze. According to Sarah Thirion, head of equity strategy at TP ICAP Europe, companies exposed to chip supply constraints could be most affected by rising costs.

“The auto and parts industry may need to lower their forecasts for 2021 in my view, in light of the semiconductor shortage,” Thirion said by email.

Accumulated Demand
While there is much pent-up demand across the economy, it’s still unclear whether order growth will prove sustainable, said Charles Glasse, manager of the Waverton European Dividend Growth Fund. Strong results for automaker Volkswagen AG saw limited market reaction as investors speculated that the surge in demand might not continue, he said.

While European equities are near their all-time highs, the 8% increase in earnings expectations in the last quarter is encouraging for some. And valuations for the Stoxx 600 index in the region are about 12% lower than a record.

“A high rating never bothered me, if the ‘E’ of K/W can improve,” says Thirion of TP ICAP. “Some companies have rethought their cost structures and recurring savings can be integrated sustainably,” she added.

Reversing a trend from last year, earnings expectations are now exceeding price gains for European equities.

Whether or not companies can live up to the rosier predictions will ultimately be shown by the many applications to be submitted in the coming weeks.

“Bad earnings news won’t be treated kindly,” said Hannah Gooch-Peters, equity investment analyst at Sanlam UK

© 2021 Bloomberg LP

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