Trends in first 3q-19 corporate results

AT A GLANCE:

As for previous earnings seasons, published US earnings so far have been better than expected (mainly among Banks, Health Care, Real Estate and Consumer-related sectors) by an average of +4% at the profits level and +1% at the revenue level. Before the reporting season started, y/y earnings were expected to be negative around -3% in the US in 3Q-19 and -2% for Europe.

It is obviously too early to draw final conclusions as only 15% of US companies have reported to date. But there are nonetheless some interesting trends to mention already in light of our sector preferences. This is the purpose of this Strategy Flash.

In Europe, the reporting season has barely begun, with only 12% of companies having disclosed figures so far. In general, sales surprises have been slightly positive and earnings surprises slightly negative in Europe, but not in a significant manner.

First trends in sectors we rate positive:

Health Care

We had been expecting a relatively good earnings season, driven by innovation, ageing population, a ‘healthy living’ better consciousness and an increasing purchasing power, particularly in less developed countries. In general, healthcare companies are well run and generate lots of cash. Moreover, in the US, they have been further supported by President Trump’s tax reform, allowing for massive share buy-backs. Guidance tended to be confirmed before the season which contributed to our positive recommendation.

And indeed, so far, several American and European bellwethers have announced better-than-expected results.

Real Estate

Very few companies have reported so far but their results have sizeably beaten expectations both at top- and bottom-line levels. We expect solid results in this sector, which is ranked among best performers this year, particularly in the US (second-best performer after Technology).

European Communication equipment

Many companies in the sector are showing great confidence these days ; some have already announced their results that have come in better than expected. ‘5G’ telephony infrastructure is being developed at an accelerated pace in several parts of the World, particularly in China and South Korea. In the US, Japan and Scandinavia, some ramp-up is being observed.

Therefore, we remain very confident about this industry that should profit from accelerating Fifth Generation investments.

Sectors we rate neutral:

Technology

Earnings momentum remains favourable in Software, especially for Cloud, Digitalisation, e-Commerce and Cybersecurity both in Europe and the US. Investments in these areas are bound to keep growing. In Europe, the first major results in the sector have confirmed improving profitability in the Software sector.

First results in the Semiconductor & Equipment sector have also been encouraging but it is also a bit early to draw definitive conclusions. Obviously, we are particularly interested in those related to communication services and infrastructure.

Financials

The sector is relatively cheap, particularly in Europe. However, the negative interest rate policy and sluggish European economies remain headwinds for the sector’s profitability in Europe. In the US, the economy is in better shape and the tax reform has significantly helped Financials, which are now relatively better capitalised, allowing for substantial buy-backs. These factors have supported the results of the US Megabanks.

US financials have so far published earnings 4% higher than expected and sales 2% higher than expected.

In Europe, we have not had major results yet. It will be interesting to observe whether European (investment) banks are still losing market share to the Americans.  

Consumer Discretionary

Not many results yet. In the Automobile sector, the mood has been depressed after several profit warnings.

Communication Services, Energy, Utilities

No significant results yet.

We expect weak results in Energy, neutral results in Communication Services and good earnings for Utilities.

Sectors we rate negative

Reminder: the key reasons for our negative views are either owing to elevated valuation ratios (Consumer staples, Industrials) and/ or poor earnings momentum (Materials). For the same reason as Materials, we have also become more cautious on Energy (i.e. we downgraded it to neutral in September) though this sector is too cheap for us to be negative on it.

Here are the current trends in the sectors where we recommend being prudent:

Consumer Staples:

A mixed bag with some solid results published by the big European groups but several food and beverage companies have disappointed, especially regarding their outlook for 2020.

The Stoxx600 Food & Beverages index has dropped by about -7% since its peak in early September. The fall has been less acute in the HPC sub-sector. However, stock price momentum remains negative in general for Consumer Staples.

This sector is the most vulnerable to a potential rotation from so-called ‘defensive growth’ stocks (relatively expensive) towards ‘value cyclicals’ (cheap and often underweighted in asset allocations).

Industrials

The sector was re-rated on the stock markets at the beginning of the year due to expectations of an economic recovery at the end of the year and due to central banks having totally changed their monetary stance this year compared with last year.

But due to trade tensions, business confidence is still weakening and investments are being delayed. The sector remains among the most vulnerable to a prolonged absence of trade agreements between the US and China and/ or to an escalation of tensions between the US and Europe.

So far, the reporting season has generally been weak for European industrials but relatively in line for the US. It is still early to draw final conclusions for Industrials.

Materials

The situation is similar to Industrials.