While European stockmarkets have continued to rise this year, the consensus of analysts’ forecasts for earnings growth by European companies has been falling.
In recent years, fund managers have become used to analysts announcing rose-tinted earnings growth estimates that are subsequently tarnished by downgrades.
But this year it appears that signs of economic recovery in Europe may be bringing about a sea change. A number of fund managers and strategists now find themselves in the unusual situation of expecting European earnings to be in line with, or even to outperform, consensus forecasts for 2014.
Kevin Lilley, fund manager of the Old Mutual European Equity (ex UK) fund, observes that at economic turning points, analysts usually get it wrong.
When economies are slowing analysts tend not to cut their numbers enough. The reverse tends to be true in times of economic recovery.
“We are in that inflection phase at the moment where European economies have been turning up during the past six to nine months or so,” said Mr Lilley.
He expects net income growth for European ex UK companies for 2014 to exceed the consensus forecast of roughly 8 per cent. “GDP numbers in European nations are still being upgraded and analysts have not yet caught up with that,” he adds.
Economic data for peripheral countries, in particular, such as Spain and Italy, has been better than expected, said Mr Lilley. The countries most burdened by austerity and company profitability could rebound faster than elsewhere in Europe. He believes domestic-facing banks such as Banco Popular or Banco Sabadell offer good exposure to recovering economies.
John Baker, co-manager of the JPM Europe Dynamic ex-UK fund, thinks consensus earnings growth figures for European companies this year are “realistic”.
“Earnings forecasts are more likely to be achieved this year than in the past,” he says.
Mr Baker believes stronger-than-expected GDP growth and an improvement in operating leverage after cost cutting should drive companies’ revenue growth.
Mr Baker does not believe the factors that held back European earnings earlier this year, such as the effect on US GDP of cold weather and euro strength, are significant. The cold weather was a one-off event and euro strength does not mean anything fundamental for a company’s underlying long-term performance.
David Moss, director of European equities at F&C, observes that many European businesses have been reporting reasonable volume growth, but it has been taken away by euro strength.
“But underlying volumes for companies are growing again across markets in Europe,” he adds.
Mr Baker highlighted areas of the market where companies’ earnings are already recovering, such as automotives.
Leaving aside Peugeot, whose earnings forecast has been downgraded heavily, BMW has benefited from faster-than-expected recovery in car demand, and Daimler from improved truck demand. Component manufacturers such as Valeo have also enjoyed earnings upgrades.
Lars Kreckel, global equity strategist at Legal & General Investment Management, expects earnings growth of roughly 10 per cent for pan-European companies in the next 12 months.
“I’m in the unusual situation where I’m a bit more optimistic than analysts’ consensus,” he highlights.
Mr Kreckel’s forecast is based on a model that tracks how earnings have behaved during the past 20 years. It factors in changes in sales-weighted GDP growth to reflect companies’ global sales and the absolute level of GDP growth, taking into account euro and commodity prices.
Dennis Jose, Barclays’ European equity strategist, is even more bullish, expecting earnings growth for Europe ex-UK companies of approximately 15 per cent this year.
He argues analysts’ forecasts did not seem to have taken into account the European cyclical recovery. European companies’ cost line could be much lower than in previous cycles because of wage-cost adjustments. Moreover, their debt refinancing costs could be lower because interest costs and corporate bonds are extremely low.
Another positive voice is Can Elbi of Swiss & Global, who manages the JB Europe Focus fund. He believes European earnings are in a trough and a three to four-year earnings upcycle will start in 2014.
Among the dissenters is Jake Robbins, manager of the Premier Global Alpha Growth fund, who does not expect earnings to recover this year. He is sceptical GDP recovery in Europe will drive growth.
“I would agree economies have stabilised but there’s little evidence that GDP is accelerating in a meaningful way,” he explains.
“In countries with extremely high joblessness, like Spain and Portugal, economic growth will not be enough to create new employment,” he argues.
Overcapacity and lack of pricing power will make it difficult for companies’ earnings growth to pick up significantly. He suspects expectations for European corporate earnings will halve from an aggregate 10-11 per cent at the start of 2014, to roughly 5 or 6 per cent by the end.
On the discrepancy between the rising market and earnings downgrades, Mr Robbins says: “The stockmarket does not seem to care. It’s very unusual for stocks to go up for such a long period of time in the face of earnings downgrades.”
