Peak profit spells danger for Europe’s earnings season

Limited reaction: VW showroom in Berlin. Strong results for VW saw a limited market reaction, as investors speculated the surge in demand may not endure. — Bloomberg

LONDON: Pain is likely to come down fast and hard for any European company that doesn’t deliver this earnings season.

At least, that’s the early read from a handful of names among the ones that have reported so far.

Online-only fashion retailer Asos Plc saw almost a fifth of its market value wiped out in a single day on weaker sales on Thursday. Just Eat and Siemens Gamesa Renewable Energy SA also tumbled after disappointing investors last week. A sales beat by UK trench-coat maker Burberry Group Plc on Friday wasn’t enough to impress investors and the shares fell as much as 5.2%.

It’s raising questions about whether the bullish exuberance in markets has reached a tipping point. Stocks are already at all-time highs and expectations for European profit growth have skyrocketed recently, with Goldman Sachs Group Inc analysts clocking the consensus increase since March as the biggest in two decades.

“Any miss or guidance downgrade will likely be severely punished,” said Julien Lafargue, chief market strategist at Barclays Private Bank. “After a very strong first quarter, expectations are elevated.”

That could limit market reaction to earnings that top forecasts, Morgan Stanley strategists including Ross MacDonald wrote in a note. A similar situation to the first quarter could play out, they said, in which the underperformance of stocks that missed estimates was more substantial than the outperformance of those that beat predictions, they said.

On average, 16 companies a day from the benchmark Stoxx Europe 600 gauge will report between now and the end of August, Goldman estimates. Amid that flood of filings, investors will fixate on 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 globe, there’s nervousness as lockdown restrictions are unwound. At the same time, the tentative reopening through the second quarter means services-focused sectors like travel and leisure could see favourable year-on-year comparisons, according to Cristina Benito, head of equities for discretionary portfolios at Mapfre AM.

Traders will be watching for red flags on inflation. Firms like Siemens Gamesa – which issued a profit warning on July 15 due to cost pressures from the rally in steel and commodity prices – are taking a hit.

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

Media and food retail are among the industries most resilient to a margin squeeze, according to a State Street report. Firms exposed to chip supply constraints may be hurt most by rising costs, according to Sarah Thirion, head of equity strategy at TP ICAP Europe.

“The auto and parts sector may, in my opinion, have to lower their 2021 forecasts, in the light of the semiconductor shortage,” Thirion said by email.

While there’s plenty of pent-up demand across the economy, it’s still unclear if order growth will prove sustainable, said Charles Glasse, manager of the Waverton European Dividend Growth Fund. Strong results for carmaker Volkswagen AG saw a limited market reaction, as investors speculated the surge in demand may not endure, he said.

Though European stocks are near an all-time high, the 8% uptick in earnings expectations in the last quarter is heartening to some. And valuations for the region’s Stoxx 600 index are down about 12% from a record.

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

In a reversal of a trend seen last year, expectations for earnings are now outpacing price gains for European stocks.

Ultimately, whether or not companies can live up to the rosier predictions will become apparent in the raft of filings due in the coming weeks.

“Bad earnings news will not be treated kindly,” said Hannah Gooch‑Peters, an equity investment analyst at Sanlam UK. — Bloomberg

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