LONDON — Europe’s corporate sector has struggled with a major problem since the 2008 financial crisis — the death of profitability.
The chief suspect, according to Barclays analysts, is low inflation.
While sales in Europe are at post-crisis highs, companies have been unable to capitalise and boost their profit margins because prices have remained stagnant, the Barclays analysts, led by Dennis Jose, said in a note to clients.
“Essentially European companies appear to have maintained sales growth this cycle by sacrificing on pricing,” Barclays said.
“This may be because European companies are price-takers rather than price-setters. Substantiating this, the strong relationship between Pricing and developed market inflation suggests that disinflation has driven poor profitability.”
This has meant European profit growth has lagged far behind behind those in the US, creating what Barclays called the most depressing chart in Europe.
It measures average earnings per share in Europe and the US.
Here it is:
And here is how the chart looks when focusing just on profit margins:
But this gap may begin to close in 2017.
“After stagnating for over half a decade, we think European earnings will finally start to grow,” Barclays said. “We forecast 10% earnings growth and, assuming no multiple expansion to account for political risk, a STOXX 600 target of 400 in 2017 (11% returns).”
Price inflation could be gradually returning to Europe at a time when labour costs are low, boosting corporate profits.
The European Central Bank has reduced benchmark interest rates to below zero and pumped liquidity into financial markets in an effort to lift inflation in the eurozone. The rate creeped up again in November, according to the latest inflation figures released by Eurostat. Consumer price inflation, the key measure of price growth, came in at 0.6% year-on-year in November, matching the earlier flash estimate provided at the end of November.
“Our models support a 50bp improvement in margins, c. 3% sales growth and therefore c. 10% earnings growth. If we are right, the cycle of negative earnings revisions may be behind us,” Barclays said.