The earnings season has started in Europe. But it’s a rather strange one. ‹All companies have stopped issuing guidance,› observes Gilles Guibout, head of European shares at AXA IM. ‹That makes it difficult for bottom-up investors. So more than ever, we need a top-down approach now.›
The earnings results announced by companies so far hardly reflect the effect of lockdowns. ‹The impact on first quarter earnings of companies with little exposure to China is still limited,› says Guibout. ‹L’Oréal, for example, announced its earnings results last Thursday. The slight decline in turnover [of 5%] was mainly due to China.›
In the dark
After all, lockdowns in Europe only started in the last few weeks of the first quarter, so the real effects will only be felt later. ‹All hairdressers and most stores in the US and Europe [where the lion’s share of L’Oréal’s sales come from] are now closed,› explains Guibout.
Franz Weis, manager of the Comgest Growth Europe fund, is also in the dark about the consequences of the ‹unprecedented› impact of the pandemic on demand and on companies› supply chains.
‹At the moment, it is almost impossible to say how earnings per share for 2020 will turn out at portfolio level, except that they will be significantly lower than last year,› he says.
It all depends on how long the lockdowns are going to last. But no one knows the answer to this question. ‹That’s why all companies are withdrawing their guidance, and investors will have to assess the situation for themselves,› says Guibout. ‹Roughly speaking, you can assume that two months without sales will lead to a 25% drop in earnings per share. If it takes three months, it will be 35-40%›.
But Guibout knows one thing for sure. ‹Companies will emerge weaker from this crisis, and the risk of a repeat of the euro crisis has increased,› says the Frenchman, adding that the latter is ‹not at all› priced in at the moment.
Equities have not become cheaper
On top of this, despite price declines of more than 20%, European equities have not become cheaper this year. ‹The average forward price/earnings ratio is now even higher than it was before the crisis because earnings expectations have plummeted. The explanation for this is the huge monetary and fiscal impulse from central banks and governments that we have seen in recent weeks›.
For Guibout, this combination of great uncertainty and a real risk of a new market correction translates into a ‹Barbell-strategy›. Despite the not insignificant risk of a new market correction, there is still a place for high-risk sectors in the portfolio, he believes. ‹Ultimately, as an equity investor, you don’t just want to manage the downside. What matters to us is maximum performance, so we have to continue to take some risk,› says the Frenchman.
This ‹risk bucket› contains companies that were hit hard by the corona crisis, but still are in a better position than most of their competitors. Like banks with relatively strong balance sheets such as BNP Paribas, ING and Intesa.
Comgest’s Weis also did not immediately say goodbye to the companies in his portfolio that were hit hardest by the corona crisis. ‹Ryanair and Inditex, with €4 billion and €8 billion in cash on their balance sheets respectively, could get through this crisis, and compare favourably with less well-managed competitors with high debts,› he says.
Secular growth trends
On the other hand, the uncertainty about the duration of lockdowns requires a higher allocation to companies that have proven more resilient against the coronavirus fall-out, as well as to quality companies with an exposure to ‹secular growth trends›. This is the biggest bucket of Guibout’s Barbell-strategy.
In mid-March, for example, he significantly increased his allocation to the telecom sector. The AXA Framlington Eurozone Equity Fund now has an allocation of 12.6% to telecom, 7.6 percentage points higher than the Euro Stoxx Index.
‹Telecoms companies should be able to maintain their sales in the crisis, and unlike most other companies, we do not expect them to cut their dividends,› says Guibout, adding: ‹The same goes more or less for healthcare companies. Dividend has become even more important for investors because interest rates will remain low for longer as a result of the crisis.›
Guibout also increased his allocation to certain utility companies. Guibout: ‹We are cautious with electricity producers who suffer from lower energy prices, and prefer regulated companies that own the network infrastructure›.
LVMH
In this part of the portfolio there is also room for ‹quality companies with a global leadership position in their sector›, such as ASML and Adyen, but also L’Oréal and LVMH. Guibout admits that he was ‹somewhat surprised› when the news broke that the latter company had planned to apply for support from the French government, but refrained from doing so at the last moment when it appeared that competitors had not applied.
‹I think it was something of a panic reaction,› believes Guibout. ‹LVMH has a strong balance sheet.› However, Guibout has reduced its allocation to the two French companies due to their strong exposure to the corona crisis.
Weis also believes that companies producing products that are in ‹structural demand› will ultimately do best. ‹Strong brands such as L’Oréal and Louis Vuitton will remain relevant after the corona crisis. People will continue to wear EssilorLuxottica glasses, companies will continue to use SAP software and manufacturers of microchips will still need ASML›s machines.›
However, even such strong companies are not immune to a recession, especially because they trade at a huge premium against the rest of the market, Guibout argues. And no matter how long the lockdowns continue, it will also take the LVMHs of this world months to get sales back to previous levels.
We’ll have to wait until summer, when the second-quarter figures come in and the impact of the corona crisis really becomes visible in companies› earnings. ‹That could provide a reason for a new market correction. Until then, the current rally can continue for a while, provided the lockdown measures in Europe and the US are gradually eased,› Guibout thinks.