Standard Life Investments

Through the Lens

European companies – weathering shocks and (finally) growing earnings

  • After five disappointing years, corporate Europe’s earnings are growing again
  • Experience operating in challenging environments is creating global players
  • We can identify opportunities in cutting-edge technology - across different sectors

A positive backdrop

Despite uncertainty remaining around European politics, the economic and corporate backdrop within the Eurozone is relatively positive at present. Companies are now in far better shape to be able to weather potential shocks than they were in the past. For five years, we have had European companies’ earnings growth forecast to be 10% - each year. Subsequently, however, each year actual earnings growth came in around 2%, disappointing investors. This year, finally, European earnings growth looks like it genuinely will reach 10%. European companies are actually delivering on investors’ expectations, despite the recent headwinds of euro strength.

Corporate change bringing growth

In fact, for investors like us who cut through the political ‘noise’ with a rigorous bottom-up investment strategy, we see many opportunities at a stock level. Many European companies with strong fundamentals now have plenty of experience operating in challenging and volatile environments, and have been growing their businesses and sales channels around the world. Some of them have undergone significant company-specific change which should drive outperformance relative to the market.

For those that ask whether European companies in sectors such as technology can compete on the global stage, and challenge their US and Asian rivals, we would suggest ASML as an interesting example. This Dutch company was created in conjunction with Philips and is the largest supplier worldwide for photolithography systems for the semiconductor industry. The world’s largest chipmakers are its customers. ASML is now benefiting from its previous heavy capital expenditure programme. We believe it should be able sustain high levels of growth and improving profitability because it has moved ahead of its rivals by adopting the next generation of technology – Extreme Ultra Violet (EUV). This enables the semiconductor industry to produce much higher performance microchips, which allows ASML’s customers to add functionality and content to semiconductor chips in a highly cost-effective manner.

Making semiconductor chips smaller is crucial for new demand such as that from the manufacturers of electronic vehicles. Electric cars present a disruptive force that threatens the survival of traditional car manufacturers, however, this is a rich opportunity for new companies to seize a slice of the global car industry. Companies in the new supply chain, such as ASML, look set to be among the winners in this industry transformation.

From semiconductors to packaging

Some companies with a technological advantage are less obvious, however, because they are not in industry sectors normally associated with a high-tech approach. An example of this is Covestro, which makes bulky chemicals and materials. These include foam mattresses and the coatings for these products. Covestro has developed sophisticated ways to make materials thinner, lighter and stronger, focusing on design options to reduce overall product weight. For several years the company invested heavily in modern equipment. The company’s timing was opportune and this expenditure is now paying off. Covestro displays good cost control and is operating in a reasonable demand environment for what is a very broad-based type of business.

We continue to find compelling opportunities in different European countries and sectors. We had been hoping for earnings growth for several years – and corporate Europe has finally delivered. This bodes well for the future, despite ongoing political uncertainty.