European Company Profits Are Rising, But Where's the Payout?

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(Bloomberg) -- For years, European stock investors have salivated over the payout their U.S. counterparts bagged from a rush of share buybacks. Even with earnings recovering, it looks like they may still be in for a letdown.

There have been high-profile exceptions recently, such as Unilever NV announcing a 6 billion-euro ($7.3 billion) share repurchase program. But on aggregate, profits distributed to shareholders through dividends or buybacks are near their lowest share of the euro area’s economy since the single currency was created in 1999, according to Credit Suisse Group AG.

That might help explain why, even as the region’s economic and earnings growth started to catch up with the U.S. last year, its stock benchmark slid to a record low last month relative to its U.S. counterpart.

Royal Dutch Shell Plc shares fell Thursday as analysts raised concerns about whether the company will be able to afford a planned $25 billion to $30 billion buyback. While French rival Total SA started to repurchase shares in the first quarter, Shell didn’t give any guidance about when its program would begin in its first-quarter earnings presentation.

But it’s not all bad -- at least if you’re not a stock investor. There are signs that with forecast earnings per share reaching the highest since the financial crisis, European companies are prioritizing capital spending and debt repayment first. The prevalence of stock buybacks in the U.S. has stoked criticism that they’re replacing investments that could create jobs and improve economic productivity in the long run.

“We expect capex to increase in Europe actually rather than cash being used to return to shareholders,” said Bibiana Carretero, a portfolio manager at EFG Asset Management in London. “For many years, companies have been focused on becoming more efficient. Now that they’re very efficient, the next phase is starting to grow again.”

Are Buybacks Good?

That’s good news for holders of European credit and the region’s economy, albeit less so for stock investors in the short term, Credit Suisse analysts led by Neville Hill wrote in a note.

In Europe, investment in machinery and equipment has picked up along with orders for German capital goods. Stronger spending is a good sign for the economy because it shows that companies are building up future capacity and could trickle down to capital goods manufacturers and their employees. In contrast, buybacks -- the criticism goes -- only return cash to investors who may not put the money to good use.

“Investing and growing the business is a much better use of corporate revenues than returning that cash to shareholders,” Credit Suisse’s Hill said in an email. It is “likely to mean upward pressure on wages rather than higher incomes for shareholders,” which should theoretically help contain income inequality, he added.

Share repurchases have always been less common in Europe, but the contrast with the U.S. has also become a lot starker as American firms made use of record-low rates and now lower taxes to hand investors a windfall. Constituents of the S&P 500 Index have splurged $4.5 trillion on dividends and buyouts in the five years through March 31, nearly double spending by Stoxx 600 stocks, data compiled by Bloomberg show. European companies’ leverage ratios are also on a downtrend -- the exact opposite of their U.S. counterparts.

However, establishing a relationship between lower payouts to shareholders and rising investment isn’t that simple. While cultural factors such as strong labor representation may be why European companies are more conservative with payouts, ultimately, growth prospects are what determines investment, said Srinivas Thiruvadanthai, research director at the Jerome Levy Forecasting Center. In Europe, capital expenditure has been driven by rising capacity utilization coinciding with improving earnings, he added.

As Europe’s corporations and banks continue to recover, it’s possible payouts will rebound, said the Credit Suisse analysts. At the same time, while shareholders -- especially activists -- may be unsuccessfully agitating for higher returns, at least the macro picture this is painting is a rosy one.

“Revenues are strong; profits are strong; investment is strong; and leverage is falling,” the analysts wrote. “At least through this lens, the fundamentals of the corporate sector, for both bond and equity holders, look good.”

©2018 Bloomberg L.P.

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