‘Europe well-positioned to deliver sustainable profit growth’

Dubai / Emirates Business

Following a period of economic uncertainty, Europe’s recovery has gathered speed over the last year and the outlook has improved considerably. In its recent edition of EMEA Perspectives, J.P. Morgan Private Bank’s Gabriele Zaninetti analyses the current investment landscape in Europe and shares his views on why Europe offers a rich source of attractive investment opportunities.
“Europe’s economy is picking up pace and investors are becoming more confident about the ability of European businesses to drive profitability and shareholder value,” said Gabriele Zaninetti, Head of Investments at J.P. Morgan Private Bank. “Fund managers expect global growth and corporate profits to be strong over the next 12 months, and investment flows into Europe have picked up this year. In fact, figures published in May by Eurostat reveal Eurozone GDP increased by an annualized rate of 2.0% in the first quarter, which is a faster rate of growth than the 0.7% reported for the US. Indications are for further acceleration in the second quarter.”
A pickup in inflation, commodities and global activity led to the return of revenue in the Eurozone and a large contribution from operating leverage to earnings per share growth. Official monetary policies remain supportive for growth, and the ECB has kept its main rate at zero and the one it pays on bank reserves at -0.4%. In addition, while political risk in Europe has troubled investors throughout 2016 and 2017, the risk of a populist outcome has diminished following the French presidential election. The result was a pivotal event in French politics and positive for European stock markets.
Zaninetti explained: “Eurozone equities have outperformed U.S. markets this year, reflecting an improving opportunity set. After several years of no top-line growth, Europe is starting from a low base and the gap between US and European margins have widened considerably over the past decade. European margins decoupled from those in the U.S. for cyclical and structural reasons, and we believe that Europe’s depressed margins represent an opportunity. If margins can expand in 2017 and 2018, the region may be on a path to delivering sustainable profit growth for the first time in a decade.”
A change in corporate behavior will also provide confidence to investors, demonstrating that firms are able to sustain their profits over the long term. Zaninetti explained: “We believe a greater focus on simplifying corporate structure, addressing underperforming businesses, tighter benchmarking and wider sharing of best practices could boost margins significantly. Encouragingly, European companies appear to be re-emphasising shareholder value. Many industries in Europe remain extremely fragmented and M&A is likely to feature as companies seek to sharpen focus and deepen market penetration. When markets consolidate, there is typically an improvement in financial returns for the whole industry.”
Across Europe, many companies have embraced research and development, technology and innovation to drive premium positioning with a quality product, and customer service to match. Motivated by tighter labour laws, automation is often seen as essential to increasing productivity, while bringing down costs, and these trends have been especially evident among smaller companies. According to Zaninetti, “the financial benefit of these investments has been hidden so far by the weak top-line environment.”
With inflation returning, premium products should be able to command greater pricing power. Price rises tend to fall straight to the bottom line and enhance operating leverage.”
Zaninetti concludes: “As home to many leading international businesses, we believe Europe offers a rich source of attractive investment opportunities. The key is to identify those companies that are well managed and have the competitive position and vision to grow their earnings well into the future.”