US and Europe Q2 Earnings Results: positive surprises but no game changer

The latest set of results has done little to reduce the markets’ high valuations levels. Meanwhile, we see the recent Q2 earnings publication as unable to alter investors’ current positioning.

As the second quarter earnings season draws to its end, we review here the main numbers and draw some conclusions for investors.

US earnings: strong profit margins and strong financials
Almost all S&P500 (456) companies published their Q2 results. At the sales level, 46% of companies beat their estimates; meanwhile, the corresponding number was 54% at the net profit level. Companies beat their sales and net profit estimates by 1.2% and 2.2% respectively, thus demonstrating strong cost control. Financials were big contributors as sales and net profit surprises came out at +0.5% and 1.5% respectively excluding this sector. Banks (37% of financials) beat sales estimates by 9% sales surprises and 8.4% at the net profit level. This sector’s hit ratio was especially impressive with 92% of reporting companies ahead of the street estimates. Oil and gas companies, which suffered from very large downgrades in 2015, reported earnings in line with expectations. Sales of material-related sectors (basic resources, chemicals, construction materials) suffered from the decline in global commodity prices, but those companies were able to post better than expected net profits. While positive, these numbers were not sufficient to alter the general US earnings picture. Thus the 2015 expected growth remains anaemic at 1.6% for the whole S&P500 and at 9.1% excluding the oil sector.

European earnings: positive surprises, strong banks but no substantial currency impact
A little more than half of Stoxx Europe 600 constituents published their numbers. Sales and net earnings surprises came out at 4% and 4.3% respectively. Excluding financials, the beat was less impressive with 0.8% at the sales level and 2.7% at the net income level. Banks had a strong quarter on the back of a rebound in loan volumes and improvements in some peripheral economies. This sector’s published sales and net income were thus 33% and 11% higher respectively than estimates. One of the key questions going into the earnings season was whether the very weak euro would boost European earnings. Unfortunately, this element failed to impact Q2 earning in a meaningful way. Investors counting on the weaker currency to boost European companies’ profit margins were clearly disappointed as this process remains very gradual. Thus, European corporates’ profit margins remain well below their US counterparts (11% versus 15%).

2015 and 2016 growth estimates essentially unchanged
Even though last quarter surprises were positive, they were not sufficient to modify the full-year estimates. Thus, the consensus EPS growth for the S&P500 remains at a quite low 1.6% while the European EPS growth estimate currently stands at 6.3%. In both cases, the growth rate has been revised substantially lower compared with the growth level expected in January, even if the European growth level has improved since April. Excluding oil and gas sectors, the S&P500 growth rate stands at 9.1% while the Stoxx Europe 600 rate stands at 11.7%.

Equity_EPS_Q2_2015-1

The last quarter results did not allow the 2016 estimates to reverse their declining trend either. Thus, US and European earnings are expected to rise by 11.1% and 11.4% respectively. In both cases, analysts expect a reversal in growth contributions from energy and cyclical sectors. The oil and gas sector contribution, which was negative in 2015, will turn positive again in 2016 (+1.3% in the US and +1.4% in Europe). Cyclical sectors’ contribution, which was very small in the current year, will double in 2016, representing about 30% of the 2016 US growth and around 40% of European earnings growth. At the other side of the spectrum, financials’ contribution will decline in both regions after a very strong 2015.

Equity_EPS_Q2_2015-2

Investment conclusion
The latest set of results has done little to reduce the markets’ high valuations levels. Based on 2016 expectations, the S&P500 and the Stoxx Europe 600 price earnings ratio currently stand at 16.7x and 15.3x respectively.

Equity_EPS_Q2_2015-3

 

We see the recent Q2 earnings publication as unable to alter investors’ current positioning. In the US, the rebound in energy and materials sectors remains uncertain as oil, and more generally commodity prices, remain under pressure. Secure growth and domestic exposure remain investors’ preferred sectors. As concentration in those sectors has grown recently (the result of growth scarcity), valuations have increased, leading to valuation premiums versus the S&P500. These premiums are supported by a strong profitability and friendly capital markets that enable US companies to reward shareholders through share buybacks and dividends in the absence of new capital spending. Since 2012, US companies have returned around 4% to shareholders. Equities thus remain attractive as interest rates remain low.

In Europe, Q2 numbers confirm the rebound in corporate earnings seen from Q1, albeit with no acceleration. Moreover, the weaker euro failed to improve corporate profitability. Finally, financials’ contribution was quite important. As in the US, the uncertainty surrounding the energy and material sectors remains too big to see a major market shift. European sectors displaying stable growth and visibility thus have valuation premiums versus the overall market, but they should retain investors’ preference. European companies’ dividend distribution remains attractive at around 3% as European yields remain compressed by the central bank QE.

 

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