Now that equity market valuation levels have considerably increased and the central banks’ very accommodative monetary policy is beginning to show its limits, corporate earnings will again capture the attention of investors. Now is a good time to review the half-year earnings of the CAC 40, which, after two waves of decline –during the great financial crisis of 2008-2009 and again during the 2011-2013 sovereign debt crisis– appear to be finally signalling the beginning of a turnaround. In fact, with only two companies posting losses in H1 2016 –Bouygues and Nokia– compared to five on average from 2013 to 2015 and as high as nine in H2 2008, H1 2009 and H2 2012, this earnings season marks a break from the past (See Chart 1).
However, a closer look reveals a more complex reality. On the business performance front, things have not really recovered and operating margins continue to stagnate. By contrast, pre-tax profits have surged and deleveraging has further increased.
Regarding business performance, the combined revenues of CAC 40 companies fell -2% in H1 2016 and even as far as -4% on a like for like basis, reflecting the mergers of Alcatel-Lucent/Nokia and Lafarge/Holcim. However, this drop has to be viewed in perspective since it is primarily attributable to energy and basic materials. Both these sectors, together referred to as commodities1, registered a decline of 21%. Apart from commodities, the revenues of the companies on the CAC 40 index remained virtually unchanged (+1% in real terms and -1% like for like), and even rose slightly if you factor in the unfavourable foreign exchange effect. In truth, although the euro remains virtually unchanged against the dollar, it appreciated almost 5% against the yuan and the pound sterling, and 20% against the rouble, the real and the rand. As these currencies, taken together, represent 20% of the CAC 40’s revenues, including China's 5% share and the UK’s 5% share, all else being equal, CAC 40 sales have been hurt by a negative foreign exchange effect of about 2.5%.
In light of this lukewarm performance, CAC 40 operating margin is flat (9.4% vs. 9.5% in H1 2015). On the other hand, pre-tax profits increased sharply (8.9% vs 8.2% in S1 2015), reaching its highest level in five years (See. Chart 2). On the one hand, this improvement is linked to the reduction in exceptional expenses and, on the other, to the improvement in the financial balance. Concerning the latter, the improvement is not only linked to low interest rates but to considerable deleveraging: the net indebtedness2 of the CAC 40 fell 25% over the last five years, half of it taking place in 2015 alone. As the tax burden does not change from one half of the year to the next (25%), the combined net income of the CAC 40 came out to €41 billion, up 7% relative to H1 2015.
Although CAC 40 earnings are beginning to recover, it is not much to brag about because, when expressed in EPS, earnings are still 29% below their 2007 peak. In comparison, French business performance is in the bottom half of the European field, midway between Spain and the United Kingdom, and a considerable distance behind the three European leaders - Sweden, Germany and Switzerland, in that order - which have almost completely caught up since 2007. This is without mentioning the United States, which is more than 30% above its initial starting point! (See Chart 3).
As to growth, on aggregate, from 2007 to 2015, nominal US GDP3 increased +25% compared to +13% for the eurozone and +12% for France! What is more, within this same period of time, France and the eurozone experienced repeated crises - with two recessions instead of one in the United States, which pulled the rug out from business. Overall, although the CAC 40 companies are internationalised to a very large extent, the weak domestic market was all the more punitive as its profitability is usually higher than average.
Turning to foreign exchange, although the euro has sharply depreciated since mid-2014, the fact remains that from year-end 2007 until then, it was trading at an average of $1.37; an obvious overvaluation that has hurt French businesses, in both terms of lost market share (net sales) and pricing power (profitability).
As to the responsiveness of business, the headcount adjustment on the CAC 40 is relatively recent. After having sharply risen from 2007 to 2011 (+9%), it is only since then that headcount has declined (-6% between 2011 and 2015). In comparison, from 2007 to 2009 in the United States –at the height of the crisis– the fifty largest companies on the S&P 500 Index immediately froze their headcount (-2%). It was only when the clouds on the horizon lifted that they timidly began rehiring (+0.9% on average between 2010 and 2015).
Turning to profit sensitivity, the companies on the CAC 40 are more cyclical than those on the S&P 500, with aggregate exposure of 48% to finance, consumer discretionary and manufacturing compared to 35% in the United States. Furthermore, their margins are –on the whole and mid-cycle– lower than on the other side of the Atlantic. Over the ten years preceding the Great Financial Crisis (1999-2008), CAC 40 net margin was 4.4% vs. 7.9% for the S&P 500. Furthermore, on the eve of the crisis (June 2007) it respectively peaked (rolling 12-month basis) at 7.7% for the CAC 40 and 9.4% for the S&P 500. This greater cyclicality and lower profitability amplifies fluctuations in earnings, both to the upside and the downside. But since France and the eurozone have known only a series of back-to-back crises, this swing has clearly played against the CAC 40.
What about the future? Now that a mild upturn in earnings has begun to take shape in the first half of 2016, will this trend grow stronger? The Sell Side consensus view is betting on the stabilisation of 2016 EPS, followed by a 10% rise in 2017 and another 11% rise in 2018. For our part, we are more optimistic about 2016 and 2017 but we are awaiting further developments regarding 2018. According to our estimates, which we summarise below, the combined net income of the CAC 40 should rise 10% in 2016 and at least that much in 2017.
It should be noted, however, that the principal ingredient missing so far has been growth. In this respect, the next twelve months are not likely to represent a real break in the macroeconomic arena, with a slight downturn in the eurozone and a slight improvement in the United States, Japan and the emerging markets. By contrast, the bottoming out of commodities and a recovery of emerging currencies could put a stop to declining4 sales in the commodities sector and lead to a more favourable foreign exchange effect. Overall, like for like, these different factors should allow revenues to rise by +1 to +2% compared to -4% in H1 2016.
As the headwinds have subsided, operating margin, which had been stagnating at the beginning of the year should improve next year, especially for commodity related stocks. Continued improvement is also projected for the financial balance. At this stage, this suggests an additional improvement in earnings of around 10%.
Going higher (+20%?) in 2017 is a possibility but it will depend on the extent of the reduction in exceptional expenses. These items, which are usually very concentrated in the second half of the year, are unpredictable in nature. However, if economic conditions remain effectively fairly stable and taking into consideration the scale of restructuring and write-downs since 2011, these expenses, having peaked in 2015, should subsequently moderate.
In conclusion, after signs of an upturn in CAC 40 earnings seen in H1 2016, further improvement until the end of 2017 appears to be quite likely in our view. On the other hand, starting in 2018, mechanical support factors –normalisation of commodities, reduction in exceptional charges, a financial balance recovery– will likely dissipate and further progress will be far more dependent on business performance and gains in productivity.
1 The term “commodities” covers three companies on the CAC 40: Arcelor-Mittal, Technip and Total
3 Over the same period, real growth rose +10% in the United States, +3% in the eurozone and +4% in France, but here we are speaking of nominal growth, as corporate financial statements are expressed in the national currency.
CAC 40 corporate earnings
This upturn is expected to