European companies haven’t faced such low earnings expectations in years, largely due to the complex geopolitical and macroeconomic environment. However, investors may only reward those companies that can protect their margins.
According to Bank of America analysis, in the three months leading up to December, more companies had their earnings estimates downgraded than upgraded compared to the previous three years. This puts the ratio firmly in “net downgrade territory.”
The pandemic and the Ukraine war disrupted global trade flows and raw material prices, leading to unprecedented levels of inflation. This inflation forced interest rates up, impacting both consumers and industries, but also boosting company margins.
Now, as the effects of these disruptions are subsiding and the global economy is slowing down, it will come down to which companies can preserve their profit margins and which cannot.
Net profit margins for the STOXX 600 peaked at 16.1 percent in the first quarter of 2023 but are expected to have fallen to 10.1 percent in the fourth quarter, according to LSEG I/B/E/S data.
However, some sectors such as consumer cyclicals, consumer non-cyclicals, financials, and industrials are expected to see an increase in their net profit margin in the fourth quarter compared to the previous period, as per the data.
Adding to the uncertainty is the disruption to global trade in the Red Sea, which has resulted in doubled freight rates, delayed deliveries, and paused production for some automotive companies, stirring concerns of another round of inflation.
“We are going to see which companies are able to keep their prices up without experiencing a huge drop in volume at a time when the economic environment is slowing down as well,” Barclays Private Bank chief market strategist Julien Lafargue said.
“It will be harder for companies to impress, not necessarily because expectations are especially high, but because it’s much more difficult to impress,” he said. “You have to show it through your business model.”
Fourth-quarter earnings are expected to decrease by 7.1 percent from the same period in 2022, while revenue is seen falling by 4.8 percent, according to LSEG I/B/E/S data.
This would mark the third straight quarter of negative earnings growth.
Key companies reporting in the coming week include chip-names ASML and STMicro, German technology group SAP, and luxury bellwether LVMH.
Following last year’s surge, analysts said strong earnings are needed to fuel further gains, especially with the challenges of geopolitics, war in Ukraine and Gaza, as well as a packed election year in 2024.
The disruption to global trade in the Red Sea has affected companies like British retailer Next and French food group Danone, while Volvo Car and Michelin have temporarily halted production at some European plants due to delays.
Attacks by Yemen’s Houthi militants on ships in the Red Sea are disrupting maritime trade through the Suez Canal, with some vessels re-routing to a much longer East-West route via the southern tip of Africa.
“With heavy reliance on a still weak manufacturing economy, ongoing disruption to global trade from several different sources, it’s hard to be particularly optimistic,” said Lindsay James, investment strategist at Quilter Investors.
Companies’ ability to raise prices will be crucial for investors, given that growth is weaker and consumers are dealing with high rates and still-hot inflation.
“What we’re looking for this earnings season, as you see pricing moderate, is which companies still have underlying volume growth. I suspect the top line will still be challenging for companies,” Aviva’s Saldanha said.
Another headwind may come from higher interest rates.
Markets had fully priced a 25-basis point cut from the European Central Bank in March. But hard push-back from various policymakers, plus evidence that the disinflationary process is proving a touch bumpy has prompted traders to cut that to just a 20 percent chance.