An encouraging start to the earnings season

Market analysis - 7/20/2018

The earnings season has begun and figures so far have been generally upbeat. However, we will need to wait for the end of next week to gain a better perspective.

The latest economic data have: - confirmed that the US recovery is still on track and that China is still growing at a good pace, - not provided any hard evidence to indicate whether Europe is still slowing or not.

Even so, the rapid slowdown in lending in China raises questions amid ongoing renminbi weakness. Insofar as this weakness has Beijing's implicit or explicit approval, analysts are wondering how to interpret the fall, especially as China’s central bank has been busy introducing a number of technical monetary easing measures. Is it about warding off any risk from the orchestrated drive to bring shadow banking under control and promote financial stability and/or the risk from higher US customs duties? Or is Beijing sending a message to the White House that it is prepared to let the renminbi fall if protectionism gains ground? We have strong doubts that China will use its currency in any trade talks. The Chinese bond market has just opened up to non-residents and the country needs this capital, making it tricky for China to put off new investors with currency losses. And the previous renminbi depreciation saw massive capital outflows that seriously worried Beijing. So why take the risk again? What is clear is that the weaker renminbi has had a negative impact on emerging country currencies and has more generally fuelled risk aversion.

The other big topic this week came from a festival of Donald Trump comments on Russia, the European Union and even the Fed. His criticism of the Fed’s monetary policy for sending the dollar higher was a big break with the US Presidential tradition of never expressing an opinion that might implicitly or explicitly question the central bank's independence. The dollar had been rising as the renminbi fell but all these comments caused it to fall.

  European equities

European equity markets rebounded in thin trading. Technology led gains on ASML’s excellent results, followed by cyclicals like autos, chemicals and industrials. Thyssenkrupp bounced sharply after its Supervisory Board chairman resigned, possibly opening the door to a more ambitious asset disposal programme. SAP reported strong cloud business momentum, but the stock was hit by a worse-thanexpected decline in licence sales. Media stocks had rebounded since the beginning of the year but led declines with Publicis tumbling 9% after a sharp fall in second quarter sales in France and Germany. Telecoms and utilities remained this week's worst performers. Even so, Iliad rebounded on news that it had signed up 1 million subscribers since launching in Italy at the end of May.

The European earnings season has got off to a good start with a reduced currency impact compared to the first quarter. In an indication of how sensitive mid cap stocks can be to the slightest disappointment, Zooplus plunged 9%, Babcock International 6%, Software AG 19%, Dormakaba and Huskvarna 18%, Leontec 11% and Rieter 15%. In stark contrast, online betting stocks surged with Evolution Gaming up 17% and LeoVegas 6% better.

  US equities

The S&P edged 0.2% higher over the week, leaving it 3% shy of last January’s all-time high. Trading moved in line with quarterly results and the Fed’s Beige Book. In macroeconomic news, June new housing starts plunged 12%, or much more than the 2% drop expected, and housing permits were down 2%. But June retail sales rose 0.5% compared to May.

The Beige Book delivered an ideal message for markets, confirming that the domestic economy was doing well but that the risk of overheating was offset by a shortage of certain resources like qualified workers, thereby putting the brakes on growth. The damage to the US economy from a trade war was also highlighted.

The market quite logically interpreted this representation of solid economic prospects- but with some constraints- as dovish. Fed chair Jerome Powell also said the labour market still had room to improve and that risks to inflationary targets were wellbalanced.

Donald Trump, however, said he was exasperated by the Fed’s policy and criticised rate hikes and the strong US dollar. Even so, he added that he left the bank to do what it thought best. In any case, these criticisms are unlikely to sway Fed policy as the President cannot replace Jerome Powell before he completes his 4-year tenure.

So far, 75 companies have released second quarter results with aggregate ESP up 21% on the second quarter of last year. IBM (+3%) saw sales rise 2% as sales as its new Strategic Imperatives businesses jumped 13%. eBay, however, plunged 10% after reducing full-year guidance. Microsoft's sales rose 17% on an 85% hike to its Azure cloud sales, a 34% increase in LinkedIn and a 38% surge in Office.

Over the last 5 trading sessions, industrials and financials led advances. Telecoms and energy lost the most ground.

  Japanese equities

Japanese equities rebounded this week as short-term investors bought back positions. The TOPIX rose 1.13%. Export stocks had remained relatively weak for months on concerns over the US-China trade war but widening valuation gaps between them and relatively expensive domestic demand stocks caused some investors to move back to oversold names, especially US-sensitive stocks (due to the upbeat US economy and dollar strength). Buying was, however, limited to fundamentally strong stocks benefiting from healthy US demand. China related-names in the machinery sector remained lacklustre on worries over slowing Chinese growth.

By sector, Air Transportation (+3.75%), Oil and Coal Products (+3.48%), Marine Transportation (+3.19%) outperformed the market. Japan Airlines rose 4.61%. Land Transportation (+2.66%) and Rubber Products (+3.01%) were relatively strong. Auto producer Suzuki and Isuzu Motor gained 6.40% and 4.08%, respectively. Yamato Holdings (parcel deliveries) soared 7.1% on expectations of higher earnings after the company raised its service charges.

On the other hand, Glass & Ceramic Products (- 0.26%), Mining (-0.21%) and Food (-0.09%) underperformed. As domestic demand stocks paused, China related names were weak. Keyence lost 4.21% and Fanuc ended 3.20% lower. Shiseido (-6.10%) was hit by profit-taking.

  Emerging markets

China's second quarter GDP growth remained strong, rising 6.7% while June industrial production came in at +6%, or slightly lower than market expectations of +6.5%. China's market remained volatile amid trade war tensions and the renminbi lost more than 1% against the US dollar over the week. There were increasing signs that stimulus measures might shortly be announced, i.e. liquidity injections via the mediumterm lending facility (MLF), loans targeted at SMEs and less stringent restrictions on new Wealth Management Product (WMP) regulations.

In Taiwan, TSMC reported a 9.1% increase in revenues and earnings in TWD but with a slight contraction in its gross margin. Its CEO struck a more cautious note on 2018 growth due to lower demand for cryptocurrency applications. Total capex for 2018 was reduced by $1.5bn to $10-10.5bn. Its progress in 7nm technology is still very encouraging.

Domestic market Chinese companies reported robust figures: Kweichow Moutai's first half sales jumped 37% with earnings up 40%. Hikvision also had an excellent first half with revenues up 27% and earnings 26% higher. In India, the government raised maximum axle load for lorries by 15-35% and the news had a very negative impact on the Ashok Leyland stock price. Infosys’ results narrowly missed expectations with annualised sales growth of 6.8% in USD and 5% for operating results, a less positive performance than its rival TCS. Hindustan Unilever reported a 21% rise in results, an excellent performance driven by 6% volume growth thanks to the introduction of the Goods & Services Tax (GST) which has helped extend standardised taxation to sector which previously did not always fully comply. Zee’s EBITDA rose 17% mainly due to a 19% jump in advertising revenue. Kotak Bank slightly missed expectations, reporting results up 17% and delivering a very cautious message on the SME segment. Thailand’s banks reported satisfying figures, up 21.5% for Kasikornbank and 14% for Bangkok Bank although profit quality fell due to a higher cost or risk. Indonesia’s Bank Mandiri reported a 17% increase in results with a lower cost of risk. Thailand’s PTTEP is selling its stake in the Montara field, where yields are diminishing, as well as related assets. Mexico’s Banco del Bajio saw second quarter earnings rise 43% YoY, or more than expected, due to loan growth and reduced provisions. Walmex announced a small (1% of market cap), but compelling acquisition in Costa Rica. Brazil's markets rose when centrist parties concluded a new alliance and decided to support Geraldo Alckmin, the most business friendly candidate. This has boosted Alckmin’s political base and he will receive 40% of available election slots on TV. CBD saw second quarter sales rise 10% or better than expected.

X5 announced a topline growth of 19.2% YoY, in line with expectations and not so bad as we have witnessed a food deflation.


Oil prices lost 2% over the week with Brent crude down to $72.6 and WTI at $69.5. The market continued to worry that demand might suffer from protectionist measures, the resumption of Libyan exports and talks over reducing US strategic reserves.

After using his favourite weapon Twitter to order OPEC to increase output, Donald Trump said he wanted to cut the Strategic Petroleum Reserve (SPR) to get petrol prices lower ahead of the mid-term elections. The SPR serves to meet any temporary crisis in supplies and currently holds 660m barrels, or the approximate equivalent of 30 domestic demand days or 3 import days. Bloomberg reported that the President wanted to reduce SPR by 30m barrels, or not enough to have more than a temporary impact on WTI prices. Elsewhere, markets reacted badly to Department of Energy weekly inventories which pointed to a rise in US crude stocks due to a sharp increase in imports and a fall in exports. At the end of the week, Russia and Saudi Arabia tried to reassure traders. Russia’s minister of energy said OPEC/non- OPEC could, if necessary, return to output levels in place before its June 22/23 commitment. The Saudis also said that exports would not exceed demand and even said that they would remain at June levels in July and should fall by 100,000 b/d in August. Saudi Arabia uses a lot of oil in the summer months due to higher electricity generation to power air conditioning. All these statements should reduce the risk of a short term oil glut.

Basic materials fell sharply over the week primarily due to US dollar strength and rising trade tensions which might cause slower growth in China, the world's biggest user of industrial metals. Copper is now trading around $6,000/tonne or its lowest level since July 2017. The gold ounce also tumbled this week to $1,223, its lowest level since July 2017, on statements by Jerome Powell and the stronger US dollar.

  Corporate debt



Trading was rather calm and thin as the summer holidays started and investors waited to see how the earnings season played out. Jerome Powell's optimistic statements had no significant impact on spreads but concerns over a possible trade war continued to weigh on sentiment. Italian gaming stocks Gamenet, IGT and SNA underperformed after Rome issued a decree banning advertising and increasing taxes on slot machines.

Telecom operator Iliad, which has recently launched in Italy, said it had already signed up 1 million subscribers. Moody’s said the arrival of this new player could intensify competition in Italy with a possible impact on Wind Tre and Telecom Italia.

In this week's earnings news, Casino (Ba1/BB+) released satisfactory figures with like-for-like sales up 5.2% due to higher food prices; the group maintained its annual targets. Netflix disappointed the market by adding fewer new subscribers than expected. In financials, Danske Bank released poor operating results and the stock was also hit by uncertainty over money laundering fines.

Denmark's telecom operator TDC (B1+/B+) is to sell its Norwegian business to Sweden’s Telia for NOK 2.1bn or 12.1x EBITDA. TDC said some of the proceeds from the sale would go towards paying back debt to maintain its credit rating. TDC bonds rose by around one point on the news but Telia’s bonds fell.

In new issues, Altice France (B1/B) raised $1.75bn and €1bn over 9 years at 8.125% and 5.875%. The issue went down well and was increased. The proceeds will be used to repay its 2022 bonds. Techem (water and energy billing services) raised €465m over 8 years at 6%.


Primary market remained active with four new deals in the US. Real estate services company Redfin Corporation raised $125m over 5 years at 1.75% for working capital purposes. Arbor Realty Trust, a real estate financing company, came to market with a $130m 3Y maturity at 5.25% for refinancing purposes.

Consumer debt management company Encore Capital issued a $150m 5Y 4.5% convertible to finance the acquisition of Janus Holdings. CalAmp, a technology company focused on connected economy solutions, issued a $200m 7Y 2% convertible for refinancing and share buyback purposes.

In China JP Morgan issued a $350m 2.5Y zero coupon synthetic exchangeable bond linked to the shares of Chinese insurer Ping An.

In the rest of the news this week, Dassault ‘s first half sales and EBIT came in 10% below consensus but net income was slightly higher than expected. Guidance for the rest of the year was confirmed amid good business jet momentum. On the morning of July 20, Bekaert (Belgium, wire and steel cables) was down close to 20% following downward revision of its 2018 outlook (volatility of wire rod prices, difficult business climate in Latin America, and low demand in oil/gas markets, etc.). Steinhoff released an update showing more than 90% creditor approval for the lock-up preceding the restructuring. It also confirmed the refinancing of Hemisphere (a new €750m senior secured loan, 3Y 10% coupon PIK). In Asia, LG Chem (South Korea) is planning to invest close de $2bn to build a second electric car battery plant in China.

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