* Europe enjoys best earnings season vs analyst forecasts
since Q3 2012
* Profits still falling, but revenues picking up
* Data shows better-than-expected GDP growth in euro zone
* Emerging market turmoil to weigh on some companies
By Maria Sheahan and Blaise Robinson
FRANKFURT/PARIS, Feb 14 Europe's corporate
profits are still eroding but investors are at last starting to
see glimmers of hope, with revenues picking up, domestic demand
recovering and good news from exposure to the United States
making up for bad news in emerging markets.
Recent weakness in emerging markets - which hit a number of
European multinationals such as Nestle, AB InBev
and Holcim - could delay the long-awaited
European earnings recovery, but probably won't derail it.
European companies have been aggressively reducing costs and
cleaning up their balance sheets in the past few years. They are
slowly starting to reap the benefits as global growth recovers,
driven by the improved momentum in developed countries.
Half way into Europe's earnings season, headline numbers are
still dire: restructuring costs and currency factors helped
drive profits nearly 5 percent lower in the quarter compared to
the fourth quarter of 2012.
But a pick-up in corporate revenue, up 2.3 percent, is
fuelling investors' hopes that the worst days are over.
Results have been good compared to analyst expectations,
with 58 percent of companies reporting profits in line or higher
than forecasts - Europe's best score since the third quarter of
2012, according to Thomson Reuters StarMine data. And surveys of
business such as the Purchasing Managers' Indexes are upbeat.
"The European PMIs for January were very good, especially
the figures for Germany. There's no doubt things are getting
better in Europe," said Ollie Beckett, fund manager at Henderson
Global Investors, which has £70.8 billion ($118 billion) in
assets under management.
"Europe has just been through two-three years of severe cost
cutting, so as soon as the European economy picks up a bit, it
will spark a big bounce in profits," he said.
Domestic demand is the key to a recovery. Data showed on
Friday the euro zone economy grew 0.3 percent in the fourth
quarter of 2013, more than expected, after a 0.1 percent rise in
the third quarter.
Companies across the region - including cancer drug maker
Roche, telecom major Vodafone and the world's
biggest steelmaker ArcelorMittal, recently cited early
signs of improvement in Europe which should bolster earnings.
"Europe is still tough but there are a number of lead
indicators," Vodafone Finance Director Andy Halford told
reporters this month, and ArcelorMittal forecast European steel
demand would return to growth this year.
Banks including Spain's Santander, the euro zone's
biggest lender, France's Societe Generale and Dutch
group ING have also reported improved earnings as they
shed bad debts and losses they suffered in the global financial
Even the overall year-on-year fall in profits was not
necessarily bad news for investors: much of it was due to
one-off restructuring charges, which should leave companies in a
better position in the future.
For example, ThyssenKrupp posted a better than
expected quarterly operating profit on Friday, despite a net
loss because of one-off charges related to the sale of a stake
in Finnish steelmaker Outokump. Big banks like BNP Paribas
and Credit Suisse saw profits hit by costly
legal settlements, but that removes future litigation risk.
There is still ample room to recover. Europe's corporate
profits overall are still 23 percent below their peak of 2008,
while U.S. corporate profits have rebounded to 23 percent above
their 2008 peak, according to Thomson Reuters Datastream data.
"Just a bit of economic growth would be enough to spur a big
rebound in corporate profits because of improved operating
leverage," said Mathieu L'Hoir, strategist at AXA Investment
Managers, which manages 536 billion euros ($727 billion).
"In Europe, profit margins are still around 5.5 percent,
versus 9 percent before the economic crisis, while in the U.S.,
margins are already back to 9 percent. A rise to 7.5 percent in
margins in Europe would spark a 40 percent bounce in profits."
Even troubled southern Europe, where demand collapsed at the
start of the euro zone debt crisis, is starting to show signs of
recovery, some analysts say.
"A strong domestic growth recovery is likely to be the
largest source of upside surprise for the Southern European
economies," Deutsche Bank strategists said last week.
ROLLER-COASTER RIDE IN EMERGING MARKETS
But an improving European economy has not filtered through
to everyone yet, with food makers and retailers in particular
still hurting as shoppers' disposable income is squeezed by
subdued wage growth and austerity measures.
Nestle warned on Thursday that 2014 would be
another challenging year as weaker emerging markets demand adds
to pain from pricing pressure at home.
Europe's No.1 retailer Carrefour saw its sales in
Europe shrink last quarter due to a tough market environment
from Italy to Poland, in addition to being hit by a
deterioration in Brazil and China, the two major emerging
markets it has earmarked for expansion.
"We're just coming out of a deep recession, and you're going
to need a longer than normal period of decent GDP growth
before you are likely to see significant earnings improvements,"
Macquarie analyst Daniel McCormack warned.
"Also, demand from emerging markets is more sluggish than
expected. Growth there is weaker, and there is less pent-up
demand than in the last cycle."
European blue-chips are more exposed to emerging market
weakness than American and Japanese peers. According to data
from MSCI, companies listed on the MSCI Europe index
have about 24 percent exposure to emerging
markets, versus 15 percent for MSCI USA and 14
percent for MSCI Japan.
Swiss engineering group ABB, among those saying it
saw more encouraging growth in many parts of Europe, cut its
medium-term sales outlook on Thursday, citing a more cautious
stance on emerging markets.
In addition, many European companies' sales and earnings
have been hurt by the drop of currencies from the Japanese yen
to the Indian rupee or the Australian dollar against the euro.
HeidelbergCement, the world's fifth-biggest cement
maker, has for instance warned that exchange rate fluctuations
would continue to impact its earnings this year after a weaker
Indonesian rupiah and Australian dollar caused it to fall short
of its own targets for 2013.
But for many European companies, bad news from emerging
markets is offset by good news from exposure to the unexpectedly
robust United States. Belgian supermarket group Delhaize
, which makes about 60 percent of its revenues in the
United States, surpassed expectations for sales growth there in
the fourth quarter.
Overall, global investors are increasingly positive about
Europe's prospects, reflected in huge inflows into the region.
Data from Thomson Reuters Lipper shows that U.S.-based funds
have poured $4.1 billion into European equities since the start
of the year, $778 million in the past week alone, a 33rd
straight week of net inflows - marking the longest streak of
weekly inflows since Lipper started to monitor flows in 1992.