Brace for Downgrades and Warnings as European Earnings Begin
Outlook Is Key as European Earnings Season Begins With Low Bar
(Bloomberg) -- After a roller-coaster start of the month for European equities dominated by Brexit and trade headlines, investors are about to get a reality check directly from companies as the earnings season gathers pace.
The bar has been set low, but amid gloomy macro indicators, strategists say the market should be braced for potential guidance disappointments and profit warnings for the rest of 2019 and beyond.
While earnings expectations have been slashed in Europe, traders will look past the quarterly results and focus on any insights about the damage from Brexit, the U.S.-China trade tension and the drop in manufacturing activity, particularly in Germany which has seen factory orders falling for 15 straight months, with no turning point in sight.
“We are in the late part of the cycle and being correctly positioned is key,” said Tomas Garcia, portfolio manager at Andorra-based MoraBanc Asset Management. “We will be closely looking at any new reduction of guidance and especially at management sentiment as to see if they anticipate a quicker deterioration, in which case we think it would be time to change our strategic positions and be out of the equities market.”
More than 300 companies in the Stoxx Europe 600 Index are scheduled to publish results in the coming weeks. Early reports of earnings give a mixed picture: Luxury giant LVMH jumped on better-than-forecast sales growth and SAP SE gained after reaffirming its outlook for this year and the next, while Royal Philips NV and Novozymes A/S tumbled after issuing profit warnings. Hugo Boss AG and Publicis Group SA also slid after cutting forecasts.
“The bad news still isn’t in prices, as profit warnings are being sanctioned with double-digit share-price declines,” Bloomberg Intelligence analyst Laurent Douillet wrote on Wednesday. Fourth-quarter guidance will be a “wake-up call for lofty expectations,” he said.
Despite the worsening economic data and trade tensions that have plagued traders in recent months, stocks have fared relatively well. After a rout at the start of the month, the Stoxx Europe 600 Index has rebounded sharply, helped in part by hopes of a Brexit deal.
“While the wider market has held up well in the face of weaker macro data so far, the potential for an increase in corporate guide-downs and analyst downgrades suggests an unattractive risk-reward profile,” Morgan Stanley strategists including Ross MacDonald and Graham Secker wrote in an Oct. 9 note.
Consensus expectations for a 2% drop in earnings-per-share growth in the third quarter don’t look “too demanding,” but double-digit projections for the current one are “unrealistic,” they said. Strategists at both Morgan Stanley and Barclays Plc predict estimates for the fourth quarter will go under the knife.
The Stoxx Europe 600 Index is up 17% in 2019. The strength of this year’s rally reduces the cushion for disappointing updates, especially from cyclical companies that are more sensitive to the economy, according to Barclays strategists led by Emmanuel Cau. The energy and materials sectors will drive a large portion of the slowdown in earnings growth this quarter, their counterparts at Deutsche Bank AG said.
Also in focus is the potential impact from the trade war between the U.S. and China., with equities being whipsawed by contrasting reports on the progress made on talks.
“Many companies have decided to put the band-aid ahead of the wound and there have been many profit warnings in the last few months,” said Gonzalo Lardies, an equity fund manager at A&G Banca Privada. “The latest earnings season is likely to be focused on company’s forward expectations, particularly in respect of the sustainability of margins and sales growth.”
Within Europe, France is likely to post the worst earnings growth and Spain the best, according to Deutsche Bank strategists led by Binky Chadha. Amid Brexit uncertainty and the slump in commodities, the outlook doesn’t look great for U.K. companies either.
Winners, Losers
Among sectors, Barclays sees the biggest risks to chemicals, autos, capital goods and hardware stocks, with strategists forecasting cyclicals will deliver much weaker earnings growth than defensives that are seen as a haven in tough times. Morgan Stanley sees downside risks for banks, transport, integrated oil and oil services, and upside potential for building & construction, food producers and software companies.
Carmakers, which have lagged behind the broader market in 2019, should deliver results in line with expectations and confirm their full-year guidance, according to UBS Group AG. The broker see no more profit warnings in store, calling it “an unusual feeling.” In the luxury sector, they see the most upside risk in the short term for France’s Kering SA and Italy’s Moncler SpA.
Analysts are also cautious on banking stocks ahead of the results season, given the prolonged low-rates environment, regulatory hurdles and risks to lending growth, and see cherry picking as the best way for those seeking exposure.
The low bar for the region’s earnings this season could, conversely, offer some scope for stock-price gains, according to David Tomas, a senior portfolio manager at Andbank Wealth Management.
“The consensus has cut estimates very sharply for this quarter,” said Tomas, “So there is a risk that anything that is not as bad as expected would be received by the market with joy and we could see shares rising.”
To contact the reporters on this story: Namitha Jagadeesh in London at njagadeesh@bloomberg.net;Macarena Munoz in Madrid at mmunoz39@bloomberg.net
To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Jon Menon
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