Unilever’s Emerging Market Pain Heralds Forecast Cuts

Asia and Latin America were the salvation for many European companies during the height of the debt crisis. Now, they’re eating into earnings.

Unilever on Sept. 30 blamed weakening currencies in Indonesia, Brazil, South Africa and India for a sales slowdown, following Adidas AG (ADS) and Prada SpA in saying the euro’s strength is eroding profit. Schneider Electric SA, Heineken (HEIA) NV and Danone (BN) are among companies most vulnerable to a profit reduction from emerging markets, analysts and investors estimate.

“You used to see growth rates in these markets in excess of GDP and that can’t go on forever,” said Hugh Cuthbert, an investment manager at SVM Asset Management in Edinburgh, who helps manage about $1.2 billion. “That’s what investors are realizing now.”

European companies may get 33 percent of sales from developing nations in 2013, almost three times as much as in 1997, after they expanded into new markets to make up for a slump at home, according to data compiled by Morgan Stanley and Bloomberg. While U.S. companies on average generate 70 percent of their revenue at home, businesses in Europe are forecast to obtain less than 50 percent from their own economies this year.

Growth Slowdown

The euro was the best performer this year of 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes, after the 17-nation euro economy emerged from its longest ever recession in the past quarter. This year, the euro has risen around 15 percent against the Indian rupee, 10 percent against the Brazilian real, 18 percent against the South African rand, 0.8 percent against the Chinese yuan and 2.5 percent against the U.S. dollar.

Among European consumer companies, brewers SABMiller Plc (SAB), Heineken and Carlsberg A/S as well as food company Danone are the most vulnerable to the emerging market slowdown, according to Barclays’ analysts including Simon Hales.

“With European consumer staples stocks deriving 50 percent of profit from emerging markets, the downside risk to earnings of a significant growth slowdown in these areas could be material,” the analysts said in a Oct. 1 note. “The dark sky just got darker,” they said, in reference to Unilever’s earnings statement the same day.

Unilever, the maker of Lipton tea and Dove soap, derives about 57 percent of sales from emerging regions such as India and China. The company this week said a slowdown in emerging markets accelerated “as a result of significant currency weakening,” pushing the stock down as as much as 4 percent in Amsterdam trading.

Forecast Cuts

Swiss watchmaker Swatch Group AG generated 37 percent of its sales from China last year, while Geneva-based Cie. Financiere Richemont SA got 41 percent from Asian countries excluding Japan, according to data compiled by Bloomberg. London-based SABMiller, the world’s second-largest brewer, gets more than 80 percent of revenue from outside Europe and North America. Nestle, the biggest food maker, got about 15 percent from Brazil, China and Mexico.

Societe Generale analyst Gael de Bray this week cut his earnings forecast for Schneider Electric, the world’s biggest maker of low- and medium-voltage power gear, as he predicts currency effects will shave 140 million euros off the company’s operating earnings in the second half, after 38 million euros in the first half.

“Some markets have been disturbed by the recent weakening in their currencies, including Russia, India, Brazil and Southeast Asia,” he said. Schneider is scheduled to report third-quarter results on Oct. 25.

Preparing Investors

Several European companies have already prepared investors for the emerging market slowdown.

Carrefour SA said Aug. 29 that the weakness of Brazilian real and the Argentine peso point to a slight reduction in the guidance for full-year recurring operating profit at France’s largest retailer. L’Oreal told investors in August that currency swings could crimp full-year sales by 3.6 percent at the world’s largest cosmetics maker.

Michelin & Cie Finance Chief Marc Henry said in July that Europe’s largest tiremaker will face currencies from emerging countries that “remain lower than the average of 2012.” German chemical company BASF SE, which is investing 10 billion euros in the Asia-Pacific region, said in July that second-quarter operating profit before some items declined because of “the devaluation of the Japanese yen.”

Diluting Profits

In Paris trading today, Michelin dropped as much as 1.8 percent, Schneider as much as 2.1 percent and Danone as much as 1.3 percent. Heineken declined as much as 0.9 percent in Amsterdam while SABMiller dropped as much as 1.3 percent in London.

Not only do weaker currencies dilute profits when translated back, it is also making it harder to compete with non-European rivals in third markets. That makes it difficult to make currency hedges to protect earnings, said Frankfurt-based Commerzbank analyst Ulrich Leuchtmann.

“The main concern is often not direct exposure, but competition in third markets,” he said, referring to the exposure of German companies to the Yen. “But businesses don’t deal with the third market problem very actively because it’s hard to get a grip on.”

Sanofi last month said it predicts full-year earnings per share to slip as much as 10 percent, more than originally forecast, after generic rivals and an underperforming unit in Brazil hurt the second-quarter sales of France’s largest drugmaker.

Low Expectations

In the pharmaceutical sector, Sanofi and German rival Bayer are the most exposed firms to a slump in emerging market sales as developing regions make up about a third of each company’s annual revenue, according to Barclays’ analysts.

“The expectations are already very low for Sanofi,” Dan Mahony, who helps manage about $9.2 billion at Polar Capital Holdings LLC. “Companies used to talk about double-digit emerging market growth. They don’t mention numbers like that anymore.”

Following the cuts in earnings and sales forecasts, European companies need to manage their exposure to emerging markets more carefully given the risk from volatile currency swings, according to Jeremy Stretch, head of currency strategy at Canadian Imperial Bank of Commerce in London.

“We’ve seen the advance of globalization and we’ve seen any number of companies being able to leverage off the back of that,” he said via phone. “It’s those countries which have big current account deficits -- whether it be India, Turkey or South Africa -- that potentially always remain at risk.”

To contact the reporters on this story: Alex Webb in Munich at awebb25@bloomberg.net; Trista Kelley in London at tkelley2@bloomberg.net; Francois de Beaupuy in Paris at fdebeaupuy@bloomberg.net

To contact the editor responsible for this story: Simon Thiel at sthiel1@bloomberg.net

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