Lower European Earnings Forecasts May Still be Too High
Analysts have turned bearish on European corporate earnings over the last 90 days, but StarMine data warns investors not to jump to the conclusion that they have become overly pessimistic; indeed, dozens of the continent’s companies may be about to deliver some negative earnings surprises.
Over the course of the last 90 days, analysts have slashed their earnings estimates for companies in the developed economies of Europe – in countries ranging from the relatively healthy regions like the Netherlands and Germany to the troubled periphery – for the next quarter for which they will report their by a remarkable 9.5%. (In some cases, that will be the second quarter of 2012; for others, the third.) That may be surprising, but what is downright dismaying is evidence indicating that while analysts have become much more pessimistic over the late spring and into the summer, they still may not be bearish enough when it comes to evaluating the future profitability of European businesses.
Although a number of European companies still report their profits and disclose their financial statements only once or twice a year, a growing number of larger companies in the region have begun to emulate their peers in North America, reporting their earnings on a quarterly basis. And since analysts are following suit, we aggregated the latters’ earnings estimates and examined how mean estimates have changed for companies in developed Europe. Certainly, the economic environment in which those companies are struggling to generate revenues and earnings is difficult, to put it mildly. Without deep structural reforms, the eurozone seems doomed to lurch from one crisis to another, triggered by the inherent defects associated with monetary union, as chronicled in a recent e-book from Reuters Breakingviews that surveys just how Europe ended up struggling to cope with such turmoil and some of the issues that will need to be resolved before it can emerge.
Unsurprisingly, as the chart below (which shows the percentage changes in both the I/B/E/S consensus estimates and the StarMine SmartEstimates over the course of the last 90 days for various countries in developed Europe) clearly illustrates, those nations that saw the biggest downward revisions in the consensus are those on the periphery that have struggled most to manage their sovereign debt burden and that have been forced to turn to their eurozone peers for help, sometimes in the shape of an outright bailout. For instance, analysts slash earnings forecasts for companies based in Portugal by a whopping 32.7% in the last 90 days; Spain – the focus of much of the current angst in the eurozone – isn’t far, behind with corporate earnings expectations having been cut a remarkable 18.3%.
Not all the downward revisions are coming from countries that find themselves in the headlines and in the eye of the storm, however. For instance, analysts have reduced consensus earnings estimates for Finland by a hefty 22.3%, but that is mostly because Finland is home to Nokia (NOK.N). Analysts now are expecting the mobile phone manufacturer to report a much larger-than-expected loss of $404 million, compared to a loss of only $124 million 90 days ago. Switzerland has seen analysts cut their quarterly earnings forecasts by 13.5%; much of that can be attributed to the ongoing turmoil in the global banking sector. Analysts have slashed their quarterly forecasts for Swiss banks’ profits by 28% over the last three months. Most intriguingly of all, perhaps, is the fact that Greece is the only country in the region of whose companies analysts now take a more bullish view than they did some 90 days ago. The country now has a positive Predicted Surprise for the quarter – although a deeper look at the reasons for that reveals the fact that it is based on only a handful of companies that have large Predicted Surprises. (A case in point is Titan Cement (TTNr.AT), which has seen the consensus move from a loss of €0.08 to an anticipated profit of €0.14 per share.)
Is it possible that analysts have become too pessimistic? If anything, a review of the StarMine SmartEstimates shows us that they haven’t been bearish enough when cutting estimates of corporate profits in virtually every country examined. In Portugal, where estimates have fallen 33%, the SmartEstimate has slumped by 36% in the same period; in Spain, it is down 24%. The aggregate SmartEstimate for Finland has been slashed by 25%; Switzerland, with its 13% decline in the consensus, has a SmartEstimate that today is 15% lower than it was 90 days ago. Overall, the 11.1% slide in the SmartEstimate for developed Europe as a whole is a sharper decline than that recorded by the consensus; reflecting the latest estimates and those of the top analysts, this usually is an indicator of the direction in which the consensus will move.
Predicted Surprise data is one way to evaluate whether analysts’ estimates have been cut by too much, relative to the fundamentals of the companies in each country. The methodology is straightforward: it’s simply a matter of running a screen on companies that have a market capitalization north of $1 billion, and then identifying the number of those that have Predicted Surprises that cross the 2% threshold, or that are more than 5%. (Those figures represent a “significant” Predicted Surprise for companies based in Europe.) To make sure that there are enough analysts’ estimates to make the results statistically significant, we winnowed out any company that didn’t have at least four analysts tracking the stock and publishing quarterly estimates.
The results are clear. While there are 37 companies that have a positive Predicted Surprise of 2% or more, the number of those likely to reported a negative earnings surprise (based on the fact that they have a negative Predicted Surprise of the same magnitude) is almost double. Increase the Predicted Surprise threshold to 5%, and you see an even greater discrepancy – for every company with a positive Predicted Surprise, there are almost three that have a negative Predicted Surprise.
For investors, the takeaway message seems clear. The downside risk is evident, and more prevalent than it was only a few months ago. That means taking pains to steer clear of companies with a negative predicted surprise, such as BHP Billiton (BLT.LN) (about whose gloomy earnings prospects we wrote only a few days ago) and Zurich Insurance Group. Happily, there are still some companies that appear likely to generate better than expected earnings, despite Europe’s ongoing economic woes, such as Novo Nordisk A/S (NOVOb.CO) and Adidas (ADS.GR), with the latter also being featured in one of our recent articles here on AlphaNow. It doesn’t pay to be reckless or premature in this kind of market context. You may think that earnings estimates have been slashed too aggressively, only to discover that they fall still more during the coming weeks and months.
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