European earnings set to power past the US

As the mid-year earnings season accelerates, here are four tailwinds driving European profit growth past the US.

The euro has fallen by about a fifth against the dollar over the past year. It averaged $1.11 in the second quarter, down from an average of $1.37 in the same period a year earlier.

Industrial, pharmaceutical, and technology companies with a strong exposure to the US market, such as Airbus, Sanofi, and SAP, are set to benefit the most. SAP earlier this week reported a larger-than-expected 20% jump in quarterly sales, helped by the weaker euro. Contrast that with results from IBM: the US technology giant saw a 9 percentage-point drag on revenue from the stronger dollar.

Falling borrowing costs, thanks to the ECB’s ultra-accommodative stance, are also set to prop up earnings. The average coupon on European investment-grade bonds has fallen to 3.1% currently from 3.8% in April 2014, and to 5.4% from 6.2% for high-yield bonds, Bloomberg data shows.

Utilities, which use debt to finance long-term projects, are among the industries that benefit most from lower financing costs. Germany’s RWE had interest expenses of about €1.08bn last year. The macro picture is also improving. The Composite PMI for the eurozone reached 54.2 in June, its highest reading since May 2011, while the manufacturing PMI reached 52.5.

Overall, companies listed on the Stoxx 600 index are expected to report on average a 6.7% increase in profits this year, with a gain of 12% for Euro Stoxx 50 firms, data compiled by Bloomberg show. That compares with an expected 1.3% gain in profits for S&P 500 companies in 2015.

“Europe’s earnings trend finally started to improve in the first quarter this year, now we need a confirmation of this turnaround,” Benoit Peloille, equity strategist at Natixis Securities in Paris, said. “Even though earnings revisions turned positive earlier this year, analysts are still very cautious in their forecasts, which means there’s room for further upgrades,” said Peloille, who sees a 13% jump in European profits this year.

According to Barclays strategists in a research note on July 16, only 41% of analyst recommendations across all stocks in the Stoxx 600 are rated “buy.”

Bloomberg