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Beating forecasts may not be enough for European firms

Source: Reuters - Tue 9th Feb 2010

The European earnings season could well see share prices retreat even if companies beat forecasts, as revenues slip and companies shrink from guiding on how they will fare in 2010.

A 57-percent rally in Europe's FTSEurofirst 300 since a low struck in March was fuelled in large part by evidence that the outlook for companies was brightening after the severe downturn in the wake of the financial crisis.

Expectations for company earnings have been marching higher over the last 12 months. In November 2009, 3,609 analysts upgraded their forecasts compared to 836 who downgraded according to Thomson Reuters I/B/E/S data.

But this trend is fading away, with the number of earnings downgrades so far this January, at 501 nearly catching up with the number of upgrades at 588.

"It is a negative indicator, analysts are more cautious, and there are plenty of reasons to become more cautious" said Jeremy Batstone-Carr, head of research at Charles Stanley.

He noted that any further sustained pickup in economic activity would lead to increased costs, making it much more difficult to deliver comparatively strong numbers in coming quarters.

"The comparative performance is going to get much tougher and that should serve as a warning to investors that just because companies deliver strong earnings beats for Q4, that doesn't mean it will be the case for all of 2010."

Earnings growth over the next twelve months is forecast at close to 30 percent and is expected to outstrip sales growth at just 5 percent, leaving plenty of scope for negative surprises on earnings. 

Investors are already expecting companies to beat their own targets, which were adjusted sharply downwards as a result of the financial crisis, but there is a sense that investors will be more demanding of companies than analysts.

"Results will quite easily beat forecasts but beating investor expectations will be quite a bit tougher" said Lars Kreckel, equity strategist at Exane BNP Paribas.

Investor focus will switch away from past performance onto the guidance of performance over the year ahead, and this is likely to be cautious at best.

"A company may release good numbers, but unless they are bullish on their expectations for the outlook, there will be little share price reaction" Kreckel said.

"Why stick your necks out to guide upwards on the outlook when there is very little incentive to do so?"

Telecoms gear maker Ericsson almost reached forecasts, but its shares fell on Monday after sales fell sharply, with investors rattled as it failed to give guidance on the year ahead.

Key to the health of the economy and therefore most major companies is how central banks and governments exit from the stimulus packages and monetary easing they implemented to deal with the crisis.

But uncertainty over how this will play out will make companies cautious about what's set to happen this year.

"They won't make strong statements" said Ad van Tiggelen, senior strategist at ING Investment Management in The Hague. 

"In 2010 consumption will be mostly based on what governments and central banks do. Most managements are just as much in the dark as investors. Nobody knows."


Other analysts are more positive on the prospects for earnings to surprise on the upside, but even the more optimistic analysts see scope for disappointment in some areas.

Christian Stocker, strategist at UniCredit Global Research in Munich, says commodity stocks should be well-supported but the telecoms sector is likely to come under pressure.

He said telecoms giants Vodafone will likely suffer from currency market moves while Deutsche Telekom, may sag on weaker customer numbers.

He also said companies dependent on capital expenditure would likely be under huge pressure as there is a reluctance for companies to lay out on new capabilities.

"No major company will invest in new machines. I think it's a very bad time for the machinery sector" he added, citing German midcap stock Bauer as an example.

He also said that banks look set to be pressured by the earnings season.

"What we have seen in the U.S., the earnings are not as good as expected, now because of the Obama speech (calling for restrictions on the sector), I cannot imagine that investors will pay a higher ratio than 1 in the price to book (ratio). 

"The margins are very, very low" he said. "Expectations are a bit too high."

Batstone Carr at Charles Stanley agreed that banks are likely to suffer from a poor reaction to their earnings and said that retailers would also likely be under pressure.

"I'm extremely wary on discretionary spending. Marks & Spencer and Next were wary for the year ahead when they reported their Christmas sales and we'll see more of that."

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