European Companies Cut Debt Most Since '03 as Earnings Jump 46%
WPP Plc CEO Martin Sorrell
Michele Tantussi/Bloomberg
“Last year was about survival,” Chief Executive Officer Martin Sorrell said in a Bloomberg Television interview Oct. 29.
“Last year was about survival,” Chief Executive Officer Martin Sorrell said in a Bloomberg Television interview Oct. 29. Photographer: Michele Tantussi/Bloomberg
Oct. 29 (Bloomberg) -- Martin Sorrell, chief executive officer of WPP Plc, talks about third-quarter earnings and the outlook for the U.S. economy. WPP's profit rose 12.2 percent to 2.25 billion pounds ($3.6 billion), beating analyst estimates, led by the continued recovery in ad spending in the U.S. and U.K. Sorrell speaks with Mark Barton on Bloomberg Television's "Countdown." (Source: Bloomberg)
While European countries slide deeper into debt, the region’s companies are paying off creditors and boosting profits at the fastest rate in seven years.
Liabilities as a percentage of earnings in the benchmark Stoxx Europe 600 Index dropped 22 percent last quarter, the most since 2003, according to data compiled by Bloomberg. Analysts say annual profit growth in Europe will average 46 percent in 2010 and 2011, more than at any time in the previous seven years. The projected income would push valuations down to the lowest levels on record excluding the three months after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008, the data show.
Dwindling debt and falling price-earnings ratios are bullish signs to GLG Partners LP, Pioneer Investments and Aegon Asset Management just as rising budget deficits push the cost of insuring bonds of Ireland, Portugal and Spain against default to record highs. To BNP Paribas Fortis Global Markets, they show executives are so concerned government bailouts will fail that they won’t take steps to reward shareholders, such as stock buybacks and mergers and acquisitions.
“After the Lehman collapse executives were very quick in the response,” said Fabio Di Giansante, a fund manager at Pioneer Investments in Dublin, which oversees $246 billion worldwide. “They cut costs and investments when they needed to, and have been able to keep the costs under control. Companies are now ready for when top-line growth kicks in.”
Ireland Package
The 5 percent advance in the Stoxx 600 this year through Nov. 26 extended its rally since March 2009 to 68 percent, data compiled by Bloomberg show. Gains were restrained by losses in the euro region’s most indebted economies, costs of providing a bailout to Greece and expectations for more charges to support Ireland. Greece’s ASE Index plunged 34 percent this year through last week, the biggest drop among 24 developed markets, while the ISEQ in Ireland fell 9.6 percent. Spain’s IBEX 35 lost 21 percent.
European governments, seeking to quell the market turmoil, handed Ireland an 85 billion-euro ($113 billion) aid package yesterday and diluted proposals to force bondholders to bear some cost of future bailouts. The Stoxx 600 tumbled 1.7 percent to 262.16 today.
European Growth
Europe’s economy is forecast to expand by 1.7 percent next year, according to the International Monetary Fund. Earnings for Stoxx 600 companies may climb 14 percent in 2011, beating the 13 percent projection for companies in the Standard & Poor’s 500, according to the average of more than 10,000 analyst estimates compiled by Bloomberg. European profits are predicted to surge 78 percent this year, the data show.
“If companies were only looking at the industry in which they operate, they would already be re-investing in those businesses -- they would have been hiring workers, they would’ve been doing M&A,” said Bill Dinning, head of investment strategy at Aegon in Edinburgh, which oversees $68 billion. “But all they hear is that the Federal Reserve and everyone else is convinced how the world is going to end unless they continue to do extraordinary things. If I look at the world bottom-up, I come to a completely different conclusion.”
Bailing Out Banks
While debt has fallen for Europe’s companies, government liabilities as a proportion of gross domestic product climbed, partly due to the cost of bailing out banks. European Union government debt reached 77.5 percent of GDP this year from 58.5 percent in 2007, according to data from the IMF. The ratio will reach 82 percent in 2012, IMF data show.
Britain’s government paid more than 65 billion pounds ($101 billion) for equity in Royal Bank of Scotland Group Plc and Lloyds Group Plc, according to data compiled by Bloomberg. Belgium spent 21 billion euros for securities in companies such as Fortis and KBC Groep NV. Ireland, which has already injected 33 billion euros into its banks, yesterday allocated 35 billion euros more.
At the same time, the proportion of debt to shareholders’ equity in the Stoxx 600 Banks Index dropped to 6.9 times last week from 16 in September 2007, according to data compiled by Bloomberg.
“It has been a shift of debt from private to public,” said Pioneer’s Di Giansante.
Enterprise Value
The Stoxx 600 ended last week at 10.4 times estimated earnings for next year, compared with 12.3 times for the S&P 500, which has gained 76 percent since bottoming in March 2009.
Enterprise value, or debt plus equity, relative to earnings before interest, taxes, depreciation and amortization has dropped to 12.8 times. That’s close to the lowest level since 2004, the data show.
“The corporate sector entered into this crisis in such better shape,” said Pierre Lagrange, senior managing director at GLG Partners in London, which oversees $25 billion. “You’re getting extraordinary profitability and extraordinary return on equity. The euro zone is in a good position. It’s a sick puppy in the world arena so that means it’s neglected.”
Executives are unlikely to borrow or increase spending until they are more confident in the economic outlook, according to Philip Gijsels, head of research at BNP Paribas Fortis Global Markets. The prospect of bigger government deficits is discouraging companies from buying rivals, hiring workers and boosting dividends, he said.
Borrowing Costs
“Re-leveraging balance sheets won’t be their first option,” said Brussels-based Gijsels. “As government debt starts appearing riskier, that will drive interest rates higher, and eventually lift corporate borrowing costs too.”
For now, corporate debt is the safest ever relative to governments, according to the credit-default swaps market. A Markit Group Ltd. index of 125 European companies dropped today to a record 78 basis points below bonds issued by countries from Greece to Germany and Italy.
European companies bought back a net $90 billion in equity this year, according to data from UBS AG. While that’s a rebound from $140 billion of net selling in 2009, it’s down from the annual average of $360 billion in repurchases between 2005 and 2007, data compiled by the investment bank show.
Takeovers of $433 billion announced this year compare with $1.51 trillion in 2007, before the credit crisis froze financing for deals, Bloomberg data show.
Companies from Accor SA, Europe’s largest hotelier, to luxury carmaker Porsche SE and WPP Plc, the biggest advertising company, are showing signs that the economic recovery is gathering momentum.
No Sad Stories
“When I or my colleagues meet companies, you don’t hear any sad stories,” said Dinning, who is betting that stocks will outperform bonds. “You need to listen to what companies are saying and you need to look at secondary indicators of business trends,” such as hotel rooms, cargo, railroads and advertising spending, Dinning said. “Those are clear signs.”
Shares of Accor, based in Evry, France, and Denham, U.K.- based Intercontinental Hotels Group Plc, the world’s largest lodging operator by number of rooms, have jumped at least 30 percent this year as travel spending recovered.
Revenue per available room in western Europe has risen 12 percent in euros this year from the same period in 2009, researcher STR Global said Nov. 24, beating the 11 percent growth rate for North America. Accor jumped to a two-year high on Oct. 21 after increasing its profit target for the year.
Cars, Ad Spending
Porsche, in Stuttgart, Germany, said Nov. 24 that operating profit surged more than sevenfold in the fiscal first quarter on demand for the Cayenne sport-utility vehicle and Panamera sedan. The stock has jumped 57 percent in November, the best monthly performance on record, according to data compiled by Bloomberg.
Bayerische Motoren Werke AG in Munich and Stuttgart-based Daimler AG’s Mercedes-Benz, the world’s two largest makers of luxury autos, will shorten Christmas breaks at factories because of increasing demand for new models, the companies said Nov. 23. Audi, the luxury unit of Volkswagen AG, plans to add shifts next month to cope with record orders.
Dublin-based WPP on Oct. 29 said third-quarter revenue rose 12 percent, beating analysts’ estimates, as spending on ads continued to recover. The owner of agencies such as Ogilvy & Mather Worldwide and Hill & Knowlton said it expects to beat its full-year margin target of a 1-point improvement. The stock has gained 19 percent in 2010, data compiled by Bloomberg show.
“Last year was about survival,” Chief Executive Officer Martin Sorrell said in a Bloomberg Television interview Oct. 29. “This year is about growing the top line.”
Biggest Banks
Market strategists at the region’s biggest banks say European equities will rise next year due to lower-than-average valuations. Societe Generale SA and Exane BNP Paribas last week forecast gains for the Stoxx 600 of 15 percent for 2011.
Paul Marson, chief investment officer at Lombard Odier Darier Hentsch U.K. Ltd., says Europe will outperform other regions next year because corporate profits and valuations will overshadow economic concerns.
“There is no correlation whatsoever between GDP growth and equity-market return,” said London-based Marson, whose company oversees $151 billion. “What matters to us are value and earnings-per-share growth.”
To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net.
To contact the editor responsible for this story: David Merritt at dmerritt1@bloomberg.net.
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