A survey of 76 corporate economists released by the National Association for Business Economics revealed increasing fear about the Eurozone posing threat to American businesses. The Eurozone has been struggling with slowing growth, deflation threats and double-digit unemployment.
The study, conducted between Sep 22 and Oct 1, revelead that 51% of the participants feared the slowdown in the Eurozone will have a “significant” or “minor” adverse effect on their businesses. While 46% still believed it will not have any impact, just 3% believes the Eurozone trouble will have a positive effect. The number of businesses worried about the Eurozone has now increased from a similar July poll. Then, 62% were confident that the global concerns would have no effect on their businesses.
The slowing European economy threatens US firms with high sales exposure to the Old Continent. For example, a good deal of material companies, including the likes of E. I. du Pont de Nemours and Company (DD) and The Dow Chemical Company (DOW), earn revenues from the Europe, the Middle East, and Africa (EMEA) region. While cyclical stocks too look to be affected, certain defensive stocks and particularly the food, beverage & tobacco stocks deriving most of their revenues from the region may be in a bad spot.
Nonetheless, investors need not worry if they can identify the risks now and adjust their portfolios accordingly. Before helping investors focus on some of those stocks, let’s look into the European growth concerns in detail.
Eurozone’s Recession Woes Intensify
The International Monetary Fund (IMF) expressed concern over stagnant growth in the Eurozone in its latest global economic outlook. Weakness in the Eurozone has also led the IMF to downgrade its global economic growth forecast this year.
According to the IMF, the Eurozone’s probability of re-entering a recession in the next six months has nearly doubled to 38% since April. This is more than rest of the world’s chance of 33%. There is also a 30% possibility of the Eurozone sliding into deflation during the same period. IMF stated inflation in the Eurozone has moved south, “indicating risks of outright deflation or a protracted period of very low inflation.”
Additionally, IMF expects the Eurozone’s GDP to grow a meager 0.8% in 2014. This is way below the U.S. and Britain’s projected growth rate of 2.2% and 3.2%, respectively.
|
Region |
2014 GDP Growth Forecast (in %) |
|||
|
Apr’2013 |
Oct’2013 |
Apr’2014 |
Oct’2014 |
|
|
Euro Area |
1.067 |
0.961 |
1.161 |
0.832 |
|
Germany |
1.455 |
1.4 |
1.709 |
1.393 |
|
France |
0.882 |
0.981 |
1.03 |
0.371 |
|
Italy |
0.516 |
0.712 |
0.626 |
-0.174 |
|
Spain |
0.738 |
0.171 |
0.868 |
1.312 |
Meanwhile, the Eurozone’s business expanded at the slowest rate this year in September. The final composite PMI for the Eurozone touched a 10-month low of 52, last month. Chris Williamson, chief economist at Markit, said: “The PMI suggests the Eurozone economy remained stuck in a rut in the third quarter.”
Another survey by Sentix showed investor sentiment in the Eurozone was negative 13.7 in October, hitting the lowest level since May 2013.
Economic data from Germany, France, Italy, among others, have also been weak. Germany, the Eurozone powerhouse, reported biggest drop in industrial output since 2009, also Markit’s retail purchasing managers’ index (PMI) showed Germany’s retail sector scored 47.1 in September, worst level in the last 53 months.
US Dollar Strengthens: Boon or Bane?
Growth worries in major economic blocks have negatively impacted their respective currencies. Most of these currencies have become weaker against the U.S. dollar as economic growth in the U.S. has outperformed the sluggish growths in these major economies.
The latest minutes of the Federal Open Market Committee’s (FOMC) Sep 16-17 meeting noted that while stronger dollar will make U.S. exports less competitive by inflating export prices, it will also reduce import prices. This is quite evident from declining trend in import prices over the past three months.
The Fed minutes noted: “Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the US external sector.” (Read: 3 Stocks in Focus on Strengthening Dollar)
Companies with High Exposure to Europe
The weakness threatens the US companies having high sales exposure to the continent. The study we spoke of earlier by the National Association for Business Economics also revealed that less numbers of corporate are upbeat about their third quarter sales. Only 49% of respondents said that their sales improved from July through September. This is a significant drop from the second quarter sales increase of 57%.
Things were a lot better in the second quarter as Europe made little impact then. In fact, FactSet had reported that more than 70% companies reporting revenues from Europe had score yearly improvements. However, the situation now seems to be on the dismal side and companies having high sales exposure may face trouble.
Let’s look at some US firms deriving a significant portion of their sales from Europe.
Consumer Stocks: Nike, Inc.’s (NKE) impressive $7,982 million sales in first quarter 2015 saw a 26.4% contribution from Europe. McDonald's Corp.’s (MCD) second quarter comparable sales had declined 1.0% and operating income remained flat in Europe. August’s comparable sales decreased 0.7% in August in Europe, wherein UK offset weakness in Russia.
The Coca-Cola Company (KO) reported net operating revenues of $12, 574 million in second quarter 2014, of which 12.5% was contributed by Europe. Coca-Cola will release third quarter numbers on Oct 21.
Of the $1,797 million second quarter net sales for Owens-Illinois, Inc. (OI), Europe had contributed $790 million, or about 44%. Philip Morris International, Inc.’s (PM) third quarter net revenue dropped 0.9% to $7,856 million. Of the total revenue, European Union accounted for 30% and Eastern Europe, Middle East & Africa contributed 31%.
In addition to the grim European economic condition, consumer spending environment, foreign exchange headwinds and declining unit volumes have been affecting the consumer sector.
Nike is the only stock among the ones discussed here that carries a favorable Zacks Rank #1 (Strong Buy). While McDonald's and Coca-Cola carry a Zacks Rank #4, Owens-Illinois and Philip Morris currently hold a Zacks Rank#5 (Strong Sell). (Read: Macroeconomic Factors Weigh on Consumer Staples Stocks)
Materials Stocks: EMEA accounted for 21.8% of DuPont’s $9.7 billion total sales in the second quarter. DuPont is scheduled to release third quarter earnings numbers on Oct 28 before the opening bell and has Earnings ESP of 1.89%.
Chemical products manufacturer Dow Chemical reported adjusted sales gain in most geographic areas in second quarter, with Western Europe sales improving 6%. Dow Chemical will release results on Oct 22. Caterpillar Inc. (CAT) reported a 17% plunge in August sales in Europe, Africa and the Middle East (EAME). Caterpillar will release third quarter earnings report on Oct 23.
While Caterpillar and Dow Chemical carry a Zacks Rank #3 (Hold) now, DuPont carries a Zacks Rank #4 (Sell).
Separately, automobile giant Ford Motor Co.’s (F) second quarter revenues of $35.3 billion had a 22.7% contribution from Europe. Premium truck manufacturer PACCAR Inc. (PCAR) reported second quarter 2014 revenues of $4,569 million. Of these, Europe had accounted for 25.3%.
Ford carries a Zacks Rank #5 and PACCAR has a Zacks Rank #3 (Hold). While Ford is scheduled to release its next earnings numbers on Oct 24, PACCAR will release results on Oct 28.
Conclusion
The prevailing situation seems to be an almost replica of what happened exactly two years back. Back in Oct 2012, Europe’s economic woes was blamed to be among the ones affecting US corporate earnings. China’s economy too back then was going through troubled waters, but US firms recognized Europe to be the weakest link.
So, investors should keep an eye on the stocks having high exposure to Europe. Coupled with that, the Zacks Ranks may help investors to identify the potential losers and gainers.
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