European shares to ride out choppy earnings

Wed Feb 6, 2013 6:23am EST

* Top analysts predict company earnings will lag consensus

* Miners, banks unlikely to be punished by earnings misses

* Healthcare sector set to surprise positively - StarMine

* Investors seek reasons to buy defensives after reporting

By Alistair Smout

LONDON, Feb 6 (Reuters) - European company earnings will lag consensus forecasts in the results season now under way but that should not put too big a dent in equity market performance, top analysts say.

While slow growth may hurt many firms' bottom line, strong demand for shares from investors, whose confidence has been lifted by easy monetary policy and reduced political risk in Europe, should limit the toll on share prices.

Companies in most sectors, including those that led stocks' rally since mid-2012, are expected to disappoint, according to analysts with strong predictive track records.

But there are bright spots, especially in so-called defensive sectors such as healthcare, where earnings should beat forecasts, and those companies' shares could be in for a lift.

"There's almost a cap on underperformance from bad results but there's still that potential for upside if you do manage to beat expectations," Adrian Cattley, pan-European equity strategist at Citi, said.

Thomson Reuters StarMine data shows the top analysts ranked by historical accuracy and timeliness expect aggregate 2012 earnings for STOXX 600 Europe companies to fall 2.7 percent compared with 2011.

For the rest of the current season, they see quarterly earnings undershooting broader consensus estimates by 1.3 percent, with estimates for 2012 missing by 1 percent.

Of all European sectors, only healthcare is forecast to deliver a positive surprise in both yearly and quarterly earnings.

While the sector recouped around a third of its 3 percent fourth-quarter stock price underperformance against the broader market in January, it remains a relative laggard and so could prove a top earnings season winner for those willing to bet now.

"These healthcare stocks are defensive stocks and they are yielding well," a UK-based healthcare sector analyst said, referring to the attractive dividend returns on offer.

"If we see evidence that Q4 has been faring better, then they (share prices) might see a bit of a tick up."

Leading the healthcare sector is Swiss company Actelion , with a 5.4 percent "predicted surprise" -- a Thomson Reuters measure which calculates the difference between consensus, as calculated through a mean of predictions, and a "smart" estimate of earnings which gives greater weight to the most accurate and up-to-date forecasts.

Actelion also features on a list of stocks favoured by Citi that have strong earnings momentum, with growth accelerating from previous periods, but whose recent underperformance gives them an attractive valuation.

ACCENTUATE THE POSITIVE

Other defensives -- sectors expected to perform well even in straitened economic times -- are expected to beat consensus on at least one front. Top analysts predict a positive surprise of 1.7 percent for consumer staples that are yet to report fourth-quarter results, but no such surprise in yearly results.

By contrast, the defensive consumer discretionary sector is expected to beat consensus for the year, but slightly miss fourth-quarter predictions.

H&M, for example, reported a negative surprise on last quarter earnings of 0.2 percent last Wednesday despite reporting strong expansion in the year as a whole.

An initial 4.2 percent drop in price became a 0.5 percent gain by the end of the day, with its valuation attractive given the stock's 0.2 percent fall over the last quarter.

"Any stocks that are defensives that beat expectations, or even narrowly miss them, will be in demand," Fawad Razaqzada, market strategist at GFT, said.

"We have been in a major risk rally recently, so people will be looking for excuses to buy these major defensive stocks, even if they ease off initially."

The rally's main beneficiaries, in the financials and materials sector, are set to post the biggest negative surprises, at 9.0 and 2.6 percent respectively for the last quarter.

Bank shares gained 10.6 percent in the last three months of 2012.

Negative earnings surprises should not hit rallying banks and miners too hard, with cheap valuations and an improving macroeconomic environment -- rather than earnings expectations -- fuelling their recent move higher.

"The rally last year wasn't about growth, and even as earnings and expectations of earnings evaporated, the market continued to move up," Mike Ingram, market analyst at BGC Partners, said.

European banks still trade at an average price-to-book value of around 1 even after the rally, meaning their equity price is just about equal to the their accounting value.

However, after six months of rallying, they look expensive compared to recent history, and with the threat of euro zone break-up diminished, banks and miners may take a back seat in any gains on equity markets until earnings improve as well.

"If a bank reports results that do disappoint market expectations, there might be quite a muted reaction to that, because there's still a supportive macro environment around the sector," Cattley said.

" given where the valuations have got to, we think that the companies with bad earnings trends are less likely to be the ongoing leaders. Performance will come from those with the better earnings trends."

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