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Profit Recession Approaching an End?

03.02.2016

As time goes by, stock prices of listed companies closely follow profit growth. We have looked closely at earnings trends in Norway, the US and Europe.

2016 has started with panic attacks in the equity markets. Whether current weakness is the start of something bigger or a buying opportunity depends on the company’s earnings. What can we expect of them?

In the stock market it is the future that counts, and the most important profit indicator is forward EPS. Forward EPS is the analysts' estimated earnings for the next twelve months.

Oil and dollar brake

On Wall Street forward EPS rolled over and went down in late 2014, and is currently five percent below the top. The declining profits during the past eighteen months reflect two factors:

Firstly, the collapse in oil prices has wiped out the earnings in the oil industry. Secondly, a super-strong dollar has shrunk earnings that US companies get overseas.

However, excluding oil and the dollar, US profit trends are robust. Oil prices are now well below sustainable levels, and this suggests that this headwind will soon turn into a tailwind.

Thus, we will not be surprised if forward EPS of S&P 500 index soon resumes its upward march.

Technological drought

Given the mixture of a weak euro and a stronger business cycle, one would think the Eurozone was in a profit party. However, this is not the case.

Forward EPS of the Euro Stoxx 50 index rose only at the beginning of last year, but the whole recovery has been reversed during the winter.

In recent months earnings fell due to estimates’ reductions in commodity and heavy industries. These sectors have been hit by the decline in the commodity market and a cooling Chinese economy.

Looking at the bigger picture, it is remarkable that the overall level of earnings in the 50 largest companies in the Eurozone is still only marginally above the bottom during the financial crisis. What has caused this?

One reason is the bad economic situation. The Eurozone only recently came out of a double dip recession which started with the financial crisis.

Secondly the profit performance of banks has been notoriously weak. While US banks took losses on rotten loans immediately, the general rule in the Eurozone has been "extend and pretend".

A third reason for the profit stagnation is what Europe lacks. Since the financial crisis much of the earnings growth on Wall Street has been driven by technology giants like Apple, Google and Amazon. However, such companies are scarce on this side of the Atlantic.

Much of the cleanup is now finished in the European banking sector. This, together with better economic conditions and significant potential for margin improvement may turn Europe into an earnings winner in the years ahead.

Burned by the oil

On the Oslo Stock exchange earnings estimates are down over 20 percent since the peak. The decline reflects the fact that oil price collapse has overwhelmed stimulus from a weak NOK.

Norwegian estimates should continue to go down. Many analysts have not yet taken the recent oil price collapse into account.

However, if oil prices are at the bottom and will eventually turn up there is a good chance that earnings levels will do the same with a slight time lag. This suggests that the profit decline is nearing its end.

15 percent yield

This week we the put Jones Act shipping company American Shipping Company into the Dovre portfolio. The company has rented out the entire fleet on long term contracts, which enables a stable dividend yield of around 15 percent.

Such yields appear to be very attractive in the current low interest rate climate. As if this was not enough, the company is also an acquisition candidate with OSG as the most likely buyer.

Dovre portfolio:

  • Panoro Energy
  • Kongsberg Automotive
  • Opera
  • Storebrand
  • DNO
  • American Shipping Company

In: American shipping Company

Out: Frontline