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European firms face share price pain from China slowdown
10/18/2013 Email this story  |  Printable Version

* Companies with exposure to China feel earnings pinch

* For many, share price has yet to react

* Top analysts expect sharper EPS fall in China-exposed stocks

* No surge in shorting of emerging market-focused stocks

By David Brett

LONDON, Oct 18 (Reuters) - European firms with exposure to China are feeling the pinch on earnings as economic growth there wanes, but many have yet to suffer a corresponding drop in stock market valuation - making their share prices ripe for correction.

Companies globally, in fields from mining to handbags, have been tapping into a growth "supercycle" in China for years, banking on an eventual explosion of middle-class consumption.

But that breakthrough has yet to happen, and growth rates in the world's second biggest economy have dropped this year. They inched back up to 7.8 percent in the third quarter but momentum looks to have slowed again since, data showed on Friday.

"These stocks have been valued highly in the past but now they are negatively impacted by the fact that China is slowing," said Claudia Panseri, global equity strategist at Societe Generale Private Banking, adding their underperformance could stretch into the fourth quarter and beyond.

Third quarter warnings over the outlook in China from the likes of Burberry, Danone, LVMH, Publicis and Unilever have seen their share prices drop by up to 10 percent.

But a broader market reaction has yet to kick in.

The warnings have led analysts whom Reuters StarMine data ranks mostly highly for earnings forecasts to cut estimates for European companies that rely on Chinese demand. Many lower-ranked analysts have yet to follow suit, meaning the gap between the two groups' sets of forecasts has widened.

Similarly, there has to date been little or no build-up of longer-term negative bets on China-exposed stocks.

"Commodities have already begun to price in this slowing demand but there are other stocks, which are exposed to the emerging market growth story that are trading very expensively and are starting to disappoint," Emmanuel Cau, strategist at JPMorgan, said.

He said valuations and earnings expectations looked stretched in the chemicals, capital goods, luxury goods and staples sectors.

"These sectors are still expensive in historical terms and consensus is still expecting relatively high earnings and margins for the next few years, but I don't think you can buy these sectors on the expectation that the last few years of earnings growth can be delivered forever."

A basket of 20 of Europe's largest listed companies with strong exposure to China and other emerging markets has lagged the broader STOXX 600 by just 2 percent in the last 30 days.

MORE DOWNGRADES, LESS MOMENTUM

There has also been little change in short interest -indicating whether investors think a share price is likely to fall - in firms directly impacted, such as Burberry and LVMH.

To short a stock, investors borrow shares and sell them in the hope of being able to buy them back more cheaply when they need to repay the loan. While borrowing in LVMH has risen from low levels since early September, borrowing of Burberry shares has fallen 80 percent, according to SunGard's Astec Analytics.

"This fall in borrowing when share prices slide tends to suggest that short sellers are seeing the price move as fair value, so feel there is less room to the downside for them to make money," Karl Loomes, market analyst for SunGard, said.

But top-ranked analysts covering Asia-focused stocks predict 2014 revenues and earnings will miss consensus forecasts by 1.4 percent and 2.8 percent respectively, compared with a 0.2 percent and 0.7 percent miss for the broader STOXX Europe 600 , according to StarMine data.

They have also been more active in downgrading the Asia-focused basket in the last 90 days with the stocks suffering 36 downgrades to recommendations, exceeding upgrades by 45 percent.

Starmine's Value-Momentum measure, which identifies stocks that are cheap for a reason rather than underpriced, has been slowing for such shares, leaving them on a lower average (40 out of 100) than the broader index of European peers (55/100).

This suggests that, while the stock prices are falling, they still do not represent fair value - which doesn't mean an eventual rebound isn't on the cards.

Neil Shah, director at Edison Investment, said the market's relative calm, particularly towards consumer-focused stocks exposed to China and other emerging markets reflected the longer-term prospects for the region.

"Everyone is focusing on the long game and rightly so. The market is being sensible," Edison's shah said.

"Short-term data is always going to cause blips ... but unless we see a fundamental turnaround in some very big trends of the rising middle class, it is unlikely that the long-term market view will change." (Editing by Nigel Stephenson, John Stonestreet)


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