Idea Of The Week: Earnings Growth in Europe Concentrated Within Eurozone

As the final results for 2015 European earnings come in, companies in the STOXX 600 index are expected to have aggregate earnings growth of 6.7% for the full year 2015. This comes despite big declines in earnings in several sectors. Similar to the U.S., energy and materials companies struggled the most, with earnings declines of 50.6% and 13.3%, respectively. Revenue results have been weak as well, with energy sector sales declining 28.9%, leading to an aggregate revenue decline of 2.6% for 2015.

Looking ahead to 2016, earnings for the STOXX 600 are expected to grow at a slower pace, as shown in the exhibit below. The current consensus estimate is for earnings to grow 4.8%, while revenue is expected to remain nearly flat, with 0.6% growth. Again, energy and materials companies are expected to see both earnings and revenue decline, but 2016 lacks any big drivers of growth, with the highest growth expected to come from consumer cyclicals at 14.6%.

Exhibit 1.  STOXX 600: 2016 Estimated EPS and Revenue growth

Source: Thomson Reuters I/B/E/S

Eurozone is key

Within the STOXX 600, there is a significant divergence in earnings between the countries that are part of the eurozone and those that are not. The index is nearly evenly divided between these two groups and each is well represented in every sector, as seen below.

Exhibit 2.  STOXX 600: Geographic Breakdown – Eurozone and Non-Eurozone

Source: Thomson Reuters I/B/E/S

Earnings expectations

By comparing earnings growth between the eurozone countries and those not in the eurozone, we see that analysts expect significantly higher earnings from the Eurozone. The eurozone countries within the STOXX 600 are collectively expected to earn 2016 profits 6.8% higher than in 2015. This compares with only 1.9% growth for countries outside of the eurozone. A similar pattern is exhibited with revenue expectations, as analysts expect eurozone countries to grow revenue 1.8%, while the remaining countries are expected to report a 1.8% revenue decline.

As seen in the exhibit below, much of the difference in growth rates stems from weakness in energy, utilities, and basic materials in the non-eurozone countries. The biggest divergence is in the energy sector, where eurozone companies are expected to outperform on earnings growth. Analysts expect eurozone energy companies to report a 1.8% earnings decline in 2016, while those outside the eurozone are expected to see earnings fall 22.3%. Of the eurozone energy companies with 2016 EPS estimates, the majority of them (7 of 12) are estimated to have positive earnings growth, while the majority of energy companies outside of the eurozone (5 of 9) are expected to see earnings decline.

The other sector that has been experiencing weakness globally is basic materials. As global demand has shrunk and commodity prices have fallen, earnings for companies in the sector have suffered. Earnings are actually expected to increase 3.3% for eurozone companies in the sector. But for companies outside of the eurozone, analysts project a 14.2% earnings decline. This difference can be partially attributed to the focus of the companies in the different regions. While the predominant industry group in both regions is chemicals, the metals & mining industry is more heavily represented outside of the eurozone, with eight of the 20 companies with 2016 estimates belonging to this industry. The weak anticipated performance of these companies is the driving factor in the dismal earnings projection for the basic materials sector as a whole.

Exhibit 3.  STOXX 600: 2016 Estimated EPS growth – Eurozone and Non-Eurozone

Source: Thomson Reuters I/B/E/S

Forecasting growth

Projected earnings growth for the eurozone is expected to outpace that of European countries outside the eurozone in seven of the 10 sectors. In addition to higher growth, however, investors should note that companies within the eurozone are also less likely to be exposed to factors that lead to big earnings declines, even in sectors with low expectations generally, like energy and basic materials.