January 17, 2014 / 10:17 AM / 4 years ago

Peripheral equity surge to stumble over earnings

* Top analysts predict European Q4 earnings will disappoint

* Euro zone stock rally looks overdone heading into results

* Selective picks in Spain and Italy favoured over Portugal

By Alistair Smout

LONDON, Jan 17 (Reuters) - European fourth-quarter earnings are set to disappoint consensus expectations, according to the most accurate analysts, potentially threatening the new year stock rally focused on Spain and Italy.

Strong gains in 2012 and 2013 have left many European indexes looking fully valued, and most analysts predict that earnings will need to improve this year if double digit gains for equities are to be repeated.

However, Thomson Reuters SmartEstimates, which weight the most accurate company analysts more heavily than consensus, predict that STOXX Europe 600 fourth-quarter earnings will miss consensus by 0.8 percent and fall 1.6 percent year on year, with Friday’s profit warning from Shell underscoring the potential for poor results.

Moreover, broad-based January gains for the euro zone periphery - which saw bourses in Spain, Italy and Portugal rise between 5 and 8 percent already in 2014 on expectations of an economic recovery - could start to appear overdone, with their earnings likely to features some big misses from their banks.

The earnings season could deliver sufficiently bad results in peripheral Europe over the next few weeks to push investors back into safe-haven German stocks, which are forecast to see resilient profit growth.

“It may be a little bit too early for Europe to show us this strong recovery in earnings. It could be a rocky period for sentiment as there’s a wait for the earnings to turn up,” Nick Nelson, European equity strategist at UBS, said.

Euro zone banks, seen as a proxy for a pick-up in domestic economic activity and benefiting from relative calm in the sovereign debt market, are up 10 percent this year.

However, with top analysts predicting some banks could miss consensus forecasts by as much as 16 percent and credit spreads widening, the sector could be in for a reality check.

Chris Parkinson, head of research at Christopher Street Capital, part of GFI Group, said the earnings season could prompt banks’ share prices to fall to close the gap with the credit market, which is pricing in greater risk for the sector.

“Earnings momentum is starting to see some deterioration in Europe ... if that continues heading into earnings season, then there is a big risk that companies which have small misses could cause a serious sell-off, as the market is so bid up,” he said.


In the last 30 days, 53 percent of analysts who have changed their view on Spanish stocks have downgraded forecasts, Thomson Reuters StarMine data showed. For Italy, the proportion is nearly 70 percent.

“That’s not conducive for a credible rise in equity,” James Butterfill, global equity strategist at Coutts, said, referring to Spain and citing concerns the market was looking expensive.

The Spanish blue chip IBEX trades at a forward 12-month price to earnings ratio of 14.2 times, the highest in Europe and at its most expensive since 2004. Analysts say valuations are unlikely to rise much further, meaning that prices can only continue to increase if earnings do too.

Portugal also looked fully valued, Butterfill said, and while Italian stocks are a bit cheaper, they also populate the list of companies set to miss consensus estimates by the most.

Italian banks Intesa Sanpaolo and UBI could miss expectations by 15.7 percent and 13.6 percent respectively, according to Thomson Reuters SmartEstimates.

While prospects for euro zone peripheral banks in general may not be overly optimistic, selective investors could benefit from better earnings from banks able to benefit from improved prospects for the region.

Spain’s BBVA leads peripheral banks with an 8 percent consensus beat predicted by top analysts, with Santander and Italian lenders UniCredit and Banco Popolare also likely to beat forecasts.

Companies in Italy and Spain could also benefit from a relatively low exposure to emerging markets, said Dennis Jose, strategist at Barclays. Falling demand and weak currencies in developing economies hit third-quarter profits for some European blue chips.

However, after the run-up in those markets, earnings misses could see investors once again flee the periphery, and head back to the region’s safe-haven the German DAX, where top analysts predict that earnings will grow by 14.8 percent.

“If earnings aren’t great, investors will look back to the core, and Germany would be one of our favoured markets,” Nelson at UBS said.

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