European companies are almost halfway through their third-quarter earnings reports, and so far earnings season has been a bit of a disappointment. But the pullback that this disappointment has caused in some European stocks offers good entry points for investors who hope to profit from the eurozone's recovery over the long term.
Year to date, investors in U.S. stocks have had a better ride than those in European equities. The S&P 500 is up almost 15% year to date, versus 13% for Germany's DAX index, 9% for France's CAC-40 and just 3.5% for the U.K.'s FTSE 100, according to data from Yahoo Finance.
In Europe, the only two sectors where earnings have exceeded expectations so far are consumer non-durables and utilities, which seems to suggest defensive companies have done better than growth-oriented equities.
With 48% of companies in the consumer non-durables sector already reporting, their year-on-year net income growth was 37.6%, according to data from FactSet.
It looks like during the third quarter that Europeans ate a lot, drank a lot of alcohol and went shopping for clothes: earnings in the meat/fish/dairy sector were up almost 60% (those rising butter prices surely helped, by the looks of it), earnings in the alcoholic beverages sector rose 48% and profits for the apparel/footwear sector increased 33%.
In the utilities sector, 46% of companies have reported so far. Growth has been driven by only two sub-sectors: water, where earnings growth has been a whopping 350%, and electricity, with 69.4% growth.
But don't reach for the shares of European water companies too quickly. The jump in the sector was exclusively due to French utilities giant Veolia Environnement (VEOEY) , which instituted deep cost cuts in the quarter to offset pressure on margins from municipalities seeking to negotiate cheaper water and wastewater rates.
In the energy and minerals sector, earnings so far are bang in line with expectations. With 38% of companies reporting, year-on-year net income growth has been 47%, driven by 50% growth in the profits of integrated oil companies and 45% for those in the oil refining/marketing sub-sector. The jump in oil prices in the past few months surely has helped these companies' results.
Among the most disappointing sectors were retail trade, where 55% of companies reported and earnings are 12% lower year on year; industrial services, with 47% of companies reporting and earnings down 32%; and consumer durables, with 45% of companies reporting and earnings 8.6% lower year on year.
It is still too early in earnings season to draw a final conclusion about the performance of European companies. So far, judging strictly by profits, it looks more like Europe is in convalescence than in full recovery mode, but the latest data could be about to change things.
On Tuesday morning, European stocks jumped after better-than-expected economic data from Germany, where the economy expanded by 0.8% in the third quarter from the second quarter, versus expectations of 0.6%. Year-on-year growth was 3.3%.
A bright outlook from Vodafone (VOD) also contributed to early investor enthusiasm in Europe. The British mobile telephony giant raised its outlook for earnings before interest, tax, depreciation and amortization (EBITDA), saying it is likely to increase by 10% this year; that figure compares with a previous forecast in the range of 4% to 8%.
With half of European companies already reporting third-quarter earnings, there is still time for defensive stocks to pass on the baton to more growth-oriented sectors such as technology, industry and transportation. Judging by the economic data, the eurozone patient is out of convalescence and well on the way to full recovery.
