Bloomberg News

European Profits Set to Trail U.S. on Lower Cost Reductions

June 27, 2011

(Adds Akzo Nobel in fifth paragraph.)

June 27 (Bloomberg) -- Narrowing margins and slowing sales at Hennes & Mauritz AB and Royal Philips Electronics NV suggest more European companies may miss analysts’ earnings estimates, underperforming U.S. peers that cut expenses in the recession.

Stockholm’s H&M, the world’s second-largest clothing retailer, and Amsterdam-based Philips were among at least five European companies that last week disclosed less-than- anticipated sales or profitability. The announcements contrast with statements from U.S. companies FedEx Corp. and Bed Bath & Beyond Inc., which both boosted profit forecasts last week.

“Since the post-recession expansion, U.S. companies have just trounced Wall Street estimates, and that hasn’t let up yet,” said Jim Paulsen, chief investment strategist for Wells Capital Management in Minneapolis, which oversees $340 billion. “Europe’s performance has been far worse than the U.S. in that regard, and I expect that will continue.”

U.S. companies had more flexibility than European peers to cut costs in the recession and they are benefiting now even though both regions have returned to peak pre-recession operating margins, said Todd Bassion, who helps manage more than $1 billion in assets at Delaware Investments in Boston.

Akzo Nobel NV, the world’s biggest paint maker, said today it will report an unexpected drop in second-quarter profit because of higher raw-material costs. Shares in the Dutch maker of the Glidden and Dulux brands dropped the most since 2008.

Labor, Cotton Prices

H&M said last week that profitability shrank in the second quarter as labor expenses rose in Asia and cotton prices increased. Philips, the biggest maker of light bulbs, said it would need to deepen cost cuts to combat deteriorating demand for lights and consumer electronics. Broadcaster Mediaset SpA of Milan, Stockholm-based clothier RNB Retail and Brands AB, and Dixons Retail Plc of Hemel Hempstead, England, were among the other European companies trailing estimates last week.

Analysts’ estimates for Stoxx Europe 600 Index companies are projected to have gained 58 percent in the quarter, while Standard & Poor’s 500 Index earnings likely rose 14 percent, the average of estimates compiled by Bloomberg. That sets up U.S. companies to have “bigger and more beats” of estimates than will happen in Europe, said Burt White, chief investment officer of Boston-based LPL Financial Corp., which manages $330 billion.

Last week’s results show bifurcation between the regions, Kenneth Fisher, the billionaire chairman and chief executive officer of Fisher Investments Inc. in Woodside, California, said in an interview.

‘Getting More Dour’

“America is doing better than we think it is,” said Fisher, who is “overweight” U.S. equities and “underweight” European stocks. “Europe has obvious real problems and was too full of itself, now it’s getting more dour.”

Philips last week said it will likely report next month that second-quarter earnings before interest, taxes and amortization at its lighting unit fell by more than half to 85 million euros ($120 million), from 210 million euros a year earlier. That compares with a 165 million-euro estimate of analysts at SNS Securities. A construction slump and weak consumer spending hurt sales of lighting and audio, video and multimedia products, the company said.

H&M said net income in the three months ended May 31 declined to 4.26 billion kronor ($660 million) from 5.21 billion kronor a year earlier and gross margin narrowed to 61.7 percent of sales from 65.9 percent.

Profit Margins

European countries such as the Netherlands and Germany haven’t laid off workers as aggressively as in the U.S., said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. The result is Europe has yet to go through the kind of painful restructuring that acts as medicine to cut costs, Zandi said.

Germany’s unemployment rate fell to at least a 20-year low in May, 7 percent, while the rate in the Netherlands rose to 5.1 percent from 5 percent in April. Those numbers compare with a 9.1 percent rate in the U.S., which had lost as many as 8.75 million jobs as a result of the recession that began in December 2007 and ended in June 2009, according to Bloomberg data.

“There’s nothing good about losing 9 million jobs, but American companies are now fundamentally” in a better place than European companies, Zandi said. “Margins are wide, balance sheets are strong, leverage is low, and cost of capital is as low as it’s ever been.”

In 2009, when most companies were scaling back following the worst recession in more than 70 years, profit margin at S&P 500 companies rose 7.9 percent, while it slumped 43 percent for the Stoxx Europe index, according to Bloomberg data.

European Opportunities

“U.S. companies often have a more flexible cost structure, so this could be part of the reason for the divergence,” Bassion of Delaware Investments said.

U.S. earnings will also be helped this quarter by a weakening dollar and sustained low interest rates, which will contribute to higher sales, White said, adding that forecasts will come down for the second half of the year.

Revenue of S&P 500 companies will climb 10 percent this year, twice the rate of 2010, according to data from analysts compiled by Bloomberg. That will help to increase 2011 profit even as companies run out of opportunities to reduce costs by firing workers or closing factories.

The S&P 500 has dropped 4.3 percent so far this quarter since March, dragged down partly by MEMC Electronic Materials Inc. and Micron Technology Inc. The best performing stocks in the index this quarter include National Semiconductor Corp., Biogen Idec Inc. and Expedia Inc.

Renewables Drop

The Stoxx Europe 600 also has fallen 4.3 percent this quarter, hurt by declines in Renewable Energy Corp., Vestas Wind Systems A/S and Bank of Ireland Plc. The best performers include Elan Corp., Rhodia SA and Hermes International SCA.

Reports of lowered profit from H&M, Philips and Dixon may be indicative of industry sector underperformance rather than geographical, said Luca Solca, global head of European research at Credit Agricole Cheuvreux in Paris. The results may not imply broad weakness in Europe, he said.

Part of the reason Germany and the Netherlands have lower unemployment is because there’s also higher growth, said Russ Koesterich, global chief investment strategist for the IShares unit of BlackRock Inc., which oversees $3.65 trillion as the world’s largest asset manager.

Using year-over-year data, Germany gross domestic product rose 4.9 percent in the first quarter, compared with 2.8 percent in the Netherlands and 2.3 percent in the U.S.

“There are opportunities in Europe, even in the eye of the hurricane,” Koesterich said in a Bloomberg Radio interview.

The difference between the U.S. and Europe is policy, Paulsen said.

“The U.S. has never turned off the monetary pump while European officials have been quick to do so,” Paulsen said. “At the same time, the U.S. talks about austerity but hasn’t actually practiced it, while Europe has been doing it all along. That’s led to bigger profits in the U.S. and a more sustained recovery.”

--With assistance from Armorel Kenna in Milan, Sara Eisen in New York and Whitney Kisling in Chicago. Editor: Romaine Bostick, Kevin Miller

To contact the reporter on this story: Alex Sherman in New York at asherman6@bloomberg.net

To contact the editor responsible for this story: Peter Elstrom at pelstrom@bloomberg.net


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