Have European Stocks Pulled Back Too Far?

 |  Includes: MON, ORAN, SYT, TOT
by: Zacks Investment Research

A major pullback in European markets recently has contributed to many investors growing concerned about a global economic slowdown. But have European stocks pulled back too far? We met with Zacks senior European markets analyst Santiago Burgaleta, CFA recently to get his outlook.

Were there any major earnings surprises in the just-reported quarter among companies in your coverage?

In the oil sector and among commodities-based stocks, there is one. Total S.A. (NYSE:TOT) reported net income of 4.73 billion euros ($7.36 billion) versus 3.41 billion euros a year earlier. Adjusted profit was 3.7 billion euros, higher than the 3.1 billion-euro estimate we had.

Total's earnings come after European competitors Shell (NYSE:RDS.A) and BP Plc (NYSE:BP) reported earlier this week jumps in dollar-denominated profit of 33 percent and 28 percent respectively but exploration and production [E&P] beat expectations on the back of stronger-than-forecast volume growth, which is very positive going forward as investors had questioned Total's ability to maintain production.

Total's oil and gas production was 2.353 million barrels of oil equivalent a day in the quarter, compared with 2.322 million barrels a day in the year-earlier period and 2.426 million barrels in the previous quarter. Total shares have been under pressure recently as Investors believe that Oil prices around 110 USD/barrel are unsustainable, but TOT's production growth and valuation does not warrant such pullback. We still believe European Refiners are pretty cheap around Europe, especially Total, so we would use weaknesses to add to positions.

Syngenta (NYSE:SYT) also surprised on the upside as net income rose to $1.52 billion from $1.22 billion, a year earlier. Syngenta, the maker of the Karate pesticide brand, raised its forecast for earnings growth this year to more than 35 percent as farmers spend more on chemicals and high-yielding crops.

Chief Executive Officer Mike Mack is stepping up his challenge to St. Louis-based Monsanto Co. (NYSE:MON), the world's No. 1 seeds maker, by expanding in genetically modified seeds that resist bugs. Syngenta now aims for “high-teens" earnings growth next year, up from its “double digit" target previously. The increase in guidance has been overlooked by investors, but once the pullback in commodities recedes, SYT shares should outperform.

Syngenta raised prices, joining other global chemical makers that are seeking to defend margins against higher raw-material costs. It uses ethyltoluene and other derivatives of oil in its chemicals, and has predicted costs will rise by as much as $50 million this year. But cost cutting measures will offset part of this squeeze.

In what ways has the slowing U.S. economy had a direct impact on the companies you follow?

SYT could be influenced by slowing demand in the US for its products, but we don't think the supposed economic downturn in the US will have a major impact on SYT accounts, as we would consider the company more consumer non-cyclical-oriented.

Results in Europe have lagged estimates by a modest 1.2%, when investors were expecting a big impact on earnings due to the US slowdown. Financials have been hit hard, but the rest of the sectors are doing pretty well on a relative basis.

Materials have surprised analysts by 30% as commodities were skyrocketing. Industrials were supposed to be hard hit by the rising Euro and have also surprised. Overall, despite the -2.5% earnings growth, European markets are down on average 24%. This is probably the biggest de-rating in the last ten years.

We believe there is value in Europe, and as investors’ risk-appetite rises, Europe should do well into year end. We do not share the bearish view in Europe. We have been cautious on the first 4 months of 2008, but we suspect European markets have seen the lows for the year and we would buy any weaknesses towards such lows.

Are there a couple top Buy recommendations you would make for us?

We would highlight France Telecom (FTE) as interest rate risk recedes in Europe. The ECB [European Central Bank] has been too aggressive rising rates to fight inflation, sacrificing GDP growth, but we believe structural inflation is in check, and as the economy slows more than in the US, we could have some monetary stimulus by the end of 2008-early 2009. Telecoms are very sensitive to rates and don't have credit problems. We would buy FTE as cash flow visibility improves and rates come down.

Santiago Burgaleta, CFA is a senior analyst covering European markets for Zacks Equity Research.