European firms face fresh wave of profit downgrades

LONDON (Reuters) - A fresh wave of cuts to European company profit forecasts is on its way but will leave firms well placed to outperform later in the year -- potentially boosting stock market returns.

By tempering analyst expectations, companies, many of which look attractive against long-term valuations, will be better placed to beat them in the coming quarters. In turn, this could fuel stock market performance after several quarters in which macroeconomic uncertainty has been the main driver.

Consensus earnings growth forecasts for European companies in 2013 have already been cut from more than 12 percent in October to about 9 percent, according to Thomson Reuters Datastream.

The number is set to fall further to about 5-6 percent after the announcement of the latest results and outlooks from more companies, reflecting the slow or negative growth expected in most European economies, analysts said.

But the pace of downgrades is slowing and signs of an (albeit slow) economic recovery, backed by central bank stimulus, means steep cuts seen last year are unlikely to be repeated, analysts said.

According to industry data, the earnings revision ratio for 2013, which measures the percentage of upgrades against downgrades, bottomed in October at 30 percent upgrades to 70 percent downgrades, before rising to 36/64 as the pace of downgrades slowed.

"We saw a brutal earnings downgrade cycle last year, but the pace is starting to slow. Once investors start getting more comfortable with the earnings outlook, they will have more confidence in valuations, which are still undemanding despite recent increases," HSBC Securities analyst Robert Parkes said.

After the latest cuts, expectations could be back to attainable levels, enabling firms to beat forecasts and leaving earnings as a potential driver for equity gains later this year.

Analysts said earnings would lend fundamental support to a stocks rally that has so far been largely driven by positive reaction to central bank actions, such as the U.S. Federal Reserve's liquidity measures and the European Central Bank's pledge to save the euro.

The FTSEurofirst 300 index <.fteu3> surged 10 percent between mid-November and early January, but the rally has since run out of steam around 23-month highs as investors wait for fresh catalysts, which could come from earnings.

"We are optimistic that we will see earnings growth of 5 to 6 percent in 2013," said Ronny Claeys, senior strategist at KBC Asset Management, which manages 62 billion euros (54 billion pounds).

"Probably we will leave negative growth territory in Europe in the second half. We are now in an environment in which you can more easily expand margins," he said.

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Estimates show variations on the country level. Earnings for German firms are forecast to be broadly flat this year after a likely rise of around 14 percent in 2012, while in Spain, where profits halved last year, a 60 percent rebound is predicted.

However, Spain risks a steep cut in estimates as the highly-indebted country faces structural challenges and the still poor economic outlook for the country could hurt companies.

On a sectoral basis, telecoms and utilities, which are highly regulated and cannot easily control pricing and margins, are seen as more vulnerable to earnings downgrades.

Analysts said earnings estimates based on company fundamentals would continue to be downgraded until mid-2013, although more slowly, before the revision ratio improves further in the second half with an economic recovery in Europe.

"Revision ratios tend to start recovering when we begin to see green shoots of a recovery. It is unlikely we will start to see the revision ratio in Europe rise until the second quarter," James Butterfill, global equity strategist at Coutts, said.

Although earnings forecasts are still being downgraded, estimates are falling just about 0.05 percent month-on-month, against a drop rate of 0.7 percent around June.

The end of the steep downgrades could help rebuild the traditionally strong positive correlation between earnings and equity performance, which had broken in the past quarters as major macroeconomic factors such as fear of a euro zone break-up and dwindling U.S. growth dominated the market.

"For several quarters, we have seen earnings moving up and stocks going down," Didier Duret, global chief investment officer at ABN AMRO Private Banking, said.

"In 2013, we will probably see a reversal of the relationship, with the market recording a good performance, but the earnings lingering in the first two quarters before recuperating in the second half."

(Reporting by Atul Prakash, editing by Toni Vorobyova and Nigel Stephenson)

Source: http://news.yahoo.com/european-firms-face-fresh-wave-profit-downgrades-134758289--finance.html

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