Analysis: Stocks at risk from big 2011 European earnings cuts

LONDON (Reuters) - European equities analysts are set to take the knife to forecasts for company earnings in 2011 as a global economic recovery slows, and how deep they cut will determine the impact on wobbly stock markets.

Analysts said that many sectors, like construction and autos, have priced in estimate cuts, sectors like retail are at risk, and the whole market would take a beating if fears of a "double-dip" recession begin to get reflected in forecasts.

Companies in the MSCI Europe index are forecast to post an 18.4-percent rise in earnings in 2011, according to Thomson Reuters I/B/E/S data, after an expected increase of 33 percent this year.

With U.S. consumer spending looking weak, China reining in its booming property market and Europe on an austerity diet, even this may be optimistic, leading to further cuts.

"The earnings cycle is beginning to turn now. If you look at the number of upgrades versus downgrades, the ratio is starting to turn down," said Gareth Evans, equity strategist at Deutsche Bank.

"There is growing concern that what we have seen in Q1 and what we are now seeing for Q2 results is sustainable through the rest of the year."

Estimates for 2011 earnings growth are falling due to softer economic activity and a higher comparison base as 2010 consensus forecasts have steadily increased over the past few months.

"Earnings are surprising on the upside for this year but they won't surprise on the upside for 2011 because you are moving into the later stage of the cycle and there is less base effect," said Nick Nelson, equity strategist at UBS.

Analysts at Credit Suisse said luxury goods, retail and aerospace & defense were the most at risk if sales growth forecasts to 2012 were halved.

Signs of weakening conditions abound.

U.S. economic growth slowed to an annualized rate of 2.4 percent in the second quarter, after an upwardly revised 3.7 percent gain in the January-March period.

China, though still outpacing growth in the developed economies, has seen its economic activity slow, with second quarter growth easing to 10.3 percent year-on-year from 11.9 percent in the first quarter.

CHEAP VALUATION SHIELD

One factor that could protect European markets as a whole from the impact of big forecast cuts is company price-to-earnings, a key measure of valuation, which suggests shares are cheap.

"If you look at the valuations of the market, they suggest that it doesn't really believe next year's consensus figures, because the market would be trading on a higher multiple," said Robert Parkes, equity strategist at HSBC.

"That's why the forward multiples are as low as they are relative to where we normally are at this point in the cycle."

MSCI Europe carries a one-year forward P/E of 10.27, versus its 20-year average of 14.98, according to Thomson Reuters DataStream. The S&P 500 has a one-year forward P/E of 11.92 against a 20-year average of 16.2.

Credit Suisse said that sectors like building materials & construction, steels, autos, media and travel and leisure had priced in the risk of a halving in sales growth forecasts.

RECESSION FEARS LURK

Cheap valuations notwithstanding, analysts said that forecasts of flat sales and flat or shrinking profits, driven by recession fears, would certainly hit the broader European market , which has risen 3.2 percent this year.

None of the sectors stress-tested by Credit Suisse had priced in a scenario of zero sales growth for two years to end-2012.

The 2011 consensus earnings growth estimates for MSCI Europe companies have been gradually cut to 18.4 percent from 28 percent in late January. Earnings increases for S&P 500 companies are also expected to soften to 15.8 percent next year from 37.5 percent in 2010.

The global economy would have to slip back into recession if consensus corporate earnings growth for 2011 were to fall into negative territory.

"The consensus numbers for next year are around plus 19 percent. We are forecasting something closer to 10 percent. To go from 19 to 10 percent, the market could manage that," UBS' Nelson said.

"But if it were going from 19 percent to say zero or negative, obviously that will be a shock to the market. The market will obviously not be able to manage that."

A recent Reuters poll of economists expected the U.S. economy to grow 2.8 percent in 2011 after expanding 3.0 percent this year and the euro zone growth rate to rise 1.1 percent in 2011 and 1.3 percent next year.

(Graphics by Scott Barber, Editing by Sitaraman Shankar)