Fri Nov 8, 2013 8:47am EST
* European companies head for worst earnings in two years
* Third-quarter top lines disappoint more than earnings
* Unfavourable currency to blame, trend seen reversing
By Atul Prakash
LONDON, Nov 8 (Reuters) - European companies are on track for their worst earnings season in two years, yet investors are taking the disappointment in their stride and forecasting an early reversal of the hit to revenues from a strong euro.
The resilience of European equities, up 14 percent in 2013 to a five-year high this week, shows investors buoyed by central banks' easy money are still moving into stocks from other assets in search of higher returns and betting that strengthening economic data will feed into higher earnings.
Three-quarters of the way through the results season, Thomson Reuters data shows half of the STOXX Europe 600 firms have missed third-quarter earnings forecasts, up from 42 percent in the second quarter and on track for their biggest disappointment since the second quarter of 2011.
The revenue front is even more bleak, with 64 percent of the companies missing sales forecasts, suggesting earnings, to a degree, had been propped up by falling costs.
Throughout the financial crisis, companies clawed up profits by cutting costs and now need revenues to improve if earnings are to keep growing.
"A lesson from the earnings season is that sales have been missing, but earnings are looking OK. This would suggest that foreign exchange is having a big influence, suppressing input costs but eroding overseas revenues," Graham Bishop, senior equity strategist at Exane BNP Paribas, said.
"Emerging markets-focused companies appear most hit, whether through forex or, more worryingly, volumes."
Analysts at Barclays, HSBC, Allianz Global Investors and Coutts also cited adverse currency movements as a key factor for the weaker sales numbers, with European exporters finding it harder to compete on price abroad and seeing their foreign currency revenues worth less and less in euros.
Of the 15 biggest sales misses by European blue chip firms, six had been driven in large part by adverse currency movements, the companies said.
Luxury goods group Richemont was the latest to warn currencies were likely to weigh on its results, joining on Friday a long list including Germany's top drugmaker Bayer and the world's top chemicals maker by sales, BASF .
While Thursday's interest rate cut by the European Central Bank may weigh on the euro, the currency has risen 8 percent against the dollar between July and late October and set a two-year peak against the dollar and a basket of currencies .
Analysts at Deutsche Bank estimate a 10 percent weakening in the dollar typically takes earnings down by 5.5 percent, suggesting the euro/dollar move in the third quarter could have hit earnings by 2-3 percent, on aggregate.
The euro also gained sharply against Asian and Latin American currencies. StarMine data showed that 90 percent of the European companies which make half or more of their sales in emerging markets, missed revenue forecasts.
HELP FROM ECB
Analysts reckoned the poor showing on revenues in the July-September period was not likely to filter through to the next quarters due to the region's positive economic prospects, an improving earnings momentum and a weaker outlook for the euro.
"If the euro stays high relative to its main trading currencies, it will continue to be a problem. However, the surprise rate cut by the ECB is likely to put downward pressure on the single currency," Barclays analyst Alex Stewart said.
The euro fell to a seven-week low against the dollar after the European Central Bank cut its main interest rate to a record 0.25 percent on Thursday and said policy would remain accommodative for as long as necessary.
"We forecast decent earnings growth and margin expansion next year as a more positive economic backdrop supports the top line and gives a boost to operating margins in Europe," said Robert Parkes, equity analyst at HSBC.
Europe's earnings momentum, which measures upgrades minus downgrades as a percentage of the total, has improved from minus 3.4 percent in July to minus 2.1 percent, data from Thomson Reuters Datastream shows, although downgrades still exceed upgrades.
"Equity markets have (been) relatively sanguine on the uninspiring earnings season so far. Looking at the marked improvements in leading indicators like PMI, investors seem prepared to exercise patience with corporate earnings for another quarter," Stefan Rondorf, equity strategist at Allianz Global Investors.
"We think this patience is justified as we see recovery dynamics in developed economies are intact and gradually broadening. Investors should be alert, but not worried."
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