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In good company

Economic news has been mixed this year but for the European corporate sector, the figures are telling a happier story


The economic news has looked a bit more mixed this year, with shoots of economic growth appearing stilted.

We have had the fiscal problems in Greece exposed in the harsh light of the bond markets. Will other European governments with high deficits and rising debt levels also be punished with higher bond yields?

In addition, the bigger eurozone countries have struggled to agree on a course of action to support Greece.

But while the government sector has looked weak this year, the corporate sector has continued to grow earnings. The crunch for companies came more than a year ago when the banking crisis cut funding for regular activities, such as trade.

The natural reaction was to save cash and hunker down. The result has been an extraordinary turn-round in the prospects for the sector with a focus on costs and significant improvements in many balance sheets. Meanwhile, equity markets are not expensive and we can find many attractive investment opportunities.

If we look beneath the surface, there are many situations that are helping to strengthen the earnings’ power of sectors or individual companies. Some of these are linked to a rising and ageing global population

Looking across Europe, earnings are forecast to increase by more than 20 per cent this year, with further growth in prospect for 2011.

The situation in the US is similar. These are healthy numbers overall. If we look at the 2010 estimated earnings’ growth for the top companies across Europe, there is significant earnings’ recovery for some banks and close to 30 per cent earnings’ improvement for the large oil companies. But in addition, there is also steady earnings’ progression for more defensive companies such as Nestlé, Novartis and Roche.

However, earnings’ growth is only half the equation. Valuation is equally important and here, European markets are looking attractive in absolute terms and against other asset classes such as bonds.

If we look at valuation on the basis of expected earnings, European share prices are approximately 12 times forecast earnings over the next year.

The average prospective price/earnings multiple over the last 15 years has been 15. Europe has an historic yield of 3.1 per cent – the same as 10-year German government bonds. We also expect dividend payments will increase this year.

If we look beneath the surface, there are many situations that are helping to strengthen the earnings’ power of sectors or individual companies.

Some of these are linked to a rising and ageing global population. Syngenta is a global leader in crop protection and seed technology. This allows countries to raise farming productivity and grow more food. There are also medical opportunities in health areas such as kidney dialysis where demand is growing.

Diabetes is also on the increase and Novo Nordisk and Sanofi-Aventis are global leaders with strong portfolios of drugs and innovative delivery systems.

Europe also leads the world in cruising, with two dominant players, Carnival and Royal Caribbean Cruises. Here, these companies are benefiting from rising demand and significant industry consolidation.

The oil sector also has promising prospects, with the pace of developments starting to improve. Exploration budgets are starting to rise and we can find interesting stocks to buy in specialist areas such as seismic survey, sub-sea equipment and seamless pipes.

Nick Dowell is manager of the HSBC European growth fund


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