Slow recovery leaves clouds over second quarter profits in Europe

Wed Jul 9, 2014 7:14am EDT

* Earnings outlook improves, but strong euro a drag

* Firms seen delivering 5-6 pct EPS growth - JPMorgan

* Reporting season unlikely to offer stock-market catalyst

* Strong euro, mixed economic outlook a drag on sentiment

By Atul Prakash

LONDON, July 9 (Reuters) - The earnings outlook for European firms is on the mend, though a spate of profit warnings and some weak economic indicators mean the second-quarter reporting season is unlikely to give investors a decisive steer.

After a rough start to the year, the pace of global economic recovery improved in the second quarter for the United States and held steady in China. But in Europe, where the euro remains obstinately strong, business activity slowed in June in powerhouse Germany and shrank in France.

Economic growth elsewhere should help European companies - which derive a substantial amount of revenue from outside Europe - to deliver earnings-per-share growth of approximately 5 percent to 6 percent, according to estimates compiled by J.P.Morgan for a sample of firms that report quarterly profit.

Pessimism about earnings has ebbed in recent weeks, with the rate of analyst earnings downgrades slowing down.

However, a persistently strong euro, which is making export prices less competitive, along with uncertainty about the strength of the economy in the second half of 2014, make some investors doubt that European shares will be able to challenge multi-year highs.

"The second quarter is going to be better than the first quarter, but not spectacularly better," said Ronny Claeys, senior strategist at KBC Asset Management.

"We don't have high expectations because we still have some major headwinds. The negative currency impact is still there and the economic recovery has been slow."

An initial raft of European trading updates on Wednesday pointed to a glum outlook, with U.K. insurer Admiral reporting a drop in six-month revenue and French caterer Sodexo cutting growth targets. By contrast, U.S. aluminium group Alcoa soundly beat analyst forecasts.

EURO HEADACHE

European exporters were hit by a first quarter rise in the euro and got no let-up from currency strength in the second quarter. The head of planemaker Airbus was the latest executive to call, on Tuesday, for the European Central Bank to take extra steps to weaken the currency.

Europe has other problems, too: Air France-KLM and Lufthansa have warned of lower profits because of competition and overcapacity, while engineer Bilfinger blamed the German shift to greener energy.

"I struggle to be optimistic about earnings in Europe," Andrea Williams, fund manager at Royal London Asset Management, said. "My concern is that second-quarter earnings season disappoints again, especially in the industrial space, particularly for those companies exposed to the power markets."

Potential winners over coming quarters include consumer-focused companies linked to the global economic recovery, such as automakers. Analysts also expect some defensive utilities like Snam and Gas Natural to deliver earnings growth.

Conversely, the full-year outlook for telecoms in France, the United Kingdom and the Netherlands is poor, mainly due on companies such as Vivendi, Vodafone and KPN , due to stiff competition and regulatory concerns. Shares in the firms have fallen 9 to 12 percent in the current quarter.

OUTLOOK

Earnings momentum needs to pick up further in the coming quarters to provide significant support to European stock markets, analysts said, with the focus likely to remain on companies' forward guidance and economic data.

Companies are likely to keep cutting costs and selling assets, even if this is less crucial than before for earnings.

Although the pan-European FTSEurofirst 300 index trades near multi-year highs, it has risen less than 5 percent this year. Britain's FTSE 100 index is almost flat.

Despite the possible lift to earnings from rock-bottom borrowing rates, few believe this will jolt investors.

"I'm not necessarily looking at this reporting season and thinking it's going to be the end of the world," Ian Richards, global head of equities strategy at Exane BNP Paribas, said.

"But I do think that we are unlikely to get a positive catalyst out of it." (Additional reporting by Tricia Wright; Editing by Lionel Laurent/Ruth Pitchford)

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