Europe's earnings boom widens beyond energy and AI

By Samuel Indyk

LONDON, Oct 20 (Reuters) - European companies are expected to deliver another quarter of exceptional earnings growth, again driven mainly by profits at energy companies and those pivotal to the datacentre buildout, although signs are emerging of strength elsewhere.

Third-quarter earnings for the pan-regional STOXX 600 are expected to grow 20.7% from a year ago, according to LSEG I/B/E/S, a slowdown from the second-quarter pace of 24%, but still among the fastest in years.

With over half of the index's market capitalisation reporting over the next two weeks, here is what you need to know as the earnings season begins:

1/ WHERE ARE THE DOWNGRADES?

In the past, analysts have typically cut earnings estimates ahead of reporting season. This time, in aggregate, they have raised forecasts, suggesting better-than-expected growth, optimism over AI spending and elevated energy prices will lead to stronger profit growth.

"Some of these dynamics look a little different than usual," David Groman, global equity strategist at Citi, said, adding they were "unseasonably strong and unusually broad".

Pre-earnings upgrades could make investors focus less on whether companies beat their third-quarter estimates and more on their outlook for the fourth quarter and beyond for clues on whether momentum can continue.

2/ ALL ABOUT AI

Europe lacks AI big-hitters, such as Nvidia, Alphabet or Samsung Electronics, but it has many smaller hardware stocks, materials and industrials that are benefiting from the capex boom.

Tech earnings are forecast to increase by almost 33% from a year ago, according to LSEG I/B/E/S, while industrials profits are expected to rise by 11%.

"It's often said Europe doesn't really have any AI plays but we think you can pick through French and German industrials," said Dorian Carrell, head of multi-asset income at Schroders.

"Expectations there have been tempered over the last few weeks, but there is a chance for European industrials to surpass expectations."

3/ ENERGY BOOST

The rise in oil and gas prices internationally since the outbreak of the US-Iran war has increased inflation and is a cost for many, but it has also boosted earnings expectations for companies that can benefit.

"The big reason for the continued upgrades for earnings this year in Europe has been the tailwind from energy prices," Barclays equity strategists said.

That support could fade if tensions in the Middle East ease and energy prices retreat, or if sustained high prices curb demand, turning the energy sector from a boost to a drag on broader earnings growth.

"We expect refining-geared names to outperform, and we think the question now is: how long this lasts," Barclays added.

4/ BANKING BOUNCE?

Europe's banks, one of the best-performing sectors in global equities over the last four years, have come under pressure from political concerns, but analysts do not anticipate a poor earnings season.

Europe's bank index is down 7% since the start of September, compared to a 1.7% drop for the broader STOXX 600, offering a lower bar to clear.

The sector trades at about 10 times its forward earnings, which are expected to grow at about 8% over the medium term, a backdrop that should support the sector going forward, according to Schroders' Carrell, especially as recent volatility has depressed expectations.

"The capital positions are strong, but the key thing is the lending activity picking up," Carrell said.

"Everything points to European banks being in a good place."

5/ CONSUMER RESILIENCE

Worries about consumers lacking spending power have lingered in Europe for years, but Maximilian Uleer, head of European equity and cross-asset strategy at Deutsche Bank, is upbeat.

Trading at 13.6 times forward earnings, Europe's consumer staples sector trades at a 35% discount to its US counterpart, which Uleer thinks is too low.

"I prefer European staples over US staples, because of the valuation difference and similar earnings profile," Uleer said. The European staples sector is expected to grow earnings by over 7% in the third quarter.

"There's good reason to believe that the consumer is more resilient than we think, especially in Europe, and that's why we like staples. I think people will be surprised by more positive numbers."

(Reporting by Samuel Indyk; Editing by Amanda Cooper and Barbara Lewis)