European Profit Outlook Robust Even With Inflation, Supply Issue

(Bloomberg) --

A surge in inflation, an energy crisis and a supply chain crunch were set to ruin Europe’s corporate profit revival and push analysts to slash their forecasts. Instead, the opposite is happening.

Weeks of robust third-quarter results have quelled analyst nerves, prompting earnings upgrades that are beating those for global peers, according to a Citigroup Inc. index. Strategists from Goldman Sachs Group Inc., UBS Global Wealth Management and Barclays Plc see next year’s profit growth boosting equities further.

That’s allaying fears about the impact of surging costs and a supply crunch in an equity market that’s hovering near record levels. Even after a 22% rally this year, the Stoxx Europe 600 Index trades at a steep discount to the S&P 500. 

“It has been a good season for third-quarter earnings despite some meaningful headwinds,” Karolina Noculak, investment director at asset management firm Abrdn, said by email. “The outlook remains bright for those that can pass on price increases and see their top line grow faster than their cost base.”

Carmakers such as BMW AG and Volkswagen AG have posted better-than-forecast earnings in the latest season, muscling through a chip shortage, while retailers such as Marks & Spencer Group Plc rallied strongly after issuing sturdy outlooks.

Such corporate resilience bodes well for equity investors grappling with the prospect of higher inflation spurring policy tightening next year. 

“Reporting season has provided fundamental justification for the equity rebound,” Emmanuel Cau, head of European equity strategy at Barclays, wrote in a note. His firm predicts double-digit earnings growth in Europe next year.

While earnings call transcripts show costs are a concern and supply bottlenecks aren’t easing, strong demand and depleted inventories are boosting pricing power, Cau says.

Firms are taking steps to mitigate the supply crunch, particularly with regards to labor shortages, according to Madison Faller, global strategist at JPMorgan Private Bank. 

“We’re seeing companies really spend and invest more in areas like innovation and automation, which can internally boost productivity and actually lower per unit cost,” she said in a phone interview. Margins are on track to remain near last quarter’s record, she added. 

To be sure, profit growth will likely decelerate quite a bit after this year’s post-pandemic jump. While Goldman Sachs strategists led by Sharon Bell predict a 13% upside for the Stoxx 600 next year, they say EPS expansion will slow down significantly next year to 6% from this year’s over 60% boom. 

The strategists recommend a mix of value and growth stocks in Europe, Renewable stocks are tipped to benefit from rising capital spending and fiscal stimulus, they said.

“What matters now is the road ahead,” added Abrdn’s Noculak, “The outlook continues to moderate but remains favorable.”

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