07.09.2010The recently completed Q2 reporting season clearly beat expectations on the Helsinki stock exchange. This time round earnings improved not only through cost control but also thanks to increasing demand. Yet the set-up is challenging with the arrival of autumn, as the recent contradictory indicators reflecting the global economy and the fears of a double dip recession keep the sentiment nervous. We think that the risks relating to the near future have increased and that the time of heavy price fluctuations is not yet history.
Mixed economic data a cause for concern
On the Helsinki stock exchange the summer was characterised by intense price fluctuations. The very strong Q2 earnings season lifted spirits in July, but in August the markets were once again looking for direction as investors tacked in the riptide caused by the improved earnings outlook, on one hand, and scenarios about a double dip recession, on the other. Now the main concern is the question of how briskly the recovery will progress, and the growth estimates for the next few years have gone under more critical scrutiny than previously. We do not believe, however, that the economy will start to falter so badly that it would crash companies' earnings potential.
As regards economic growth, Europe has deviated from the main stream as the published data has been a positive surprise, especially thanks to Germany's strong export growth. Similarly, Finland's growth figures have been a positive read, and Finnish companies' solid H1 earnings and the more encouraging outlook for the remainder of 2010 continue to lend support to Finnish equity investments. The relative attractiveness of Finnish equities is also boosted by the expectations of extra dividends as a result of the ongoing discussion on taxes.
Year-to-date the Helsinki stock exchange (OMXH Cap) has risen a little less than 14%, adjusted for dividends, while the global equity market has gained a little over 6% (MSCI World) in the same period in euro terms. Of the heavy-weight sectors, the best performer on the Helsinki stock exchange this year has been the forestry sector, which has been supported by cost cuts as well as the doubling of the pulp price from the record lows in the previous year.
H1 results exceeded expectations
Similarly to European and US companies, Finnish listed companies also surprised the markets with their better-than-expected H1 earnings. In the preceding quarters the improvement in earnings has mainly been explained by successful streamlining measures, but in Q2 the stronger-than-expected trend in net sales also supported earnings growth considerably. Over 90% of the most traded companies achieved net sales meeting forecasts or exceeding them. As regards earnings, nearly 60% of these companies beat market expectations and 20% fulfilled them.
Another sign of the improved situation of Finnish companies is that the number of new orders increased clearly more than forecast. Engineering companies across the board reported that they had received more new orders than forecast, which indicates improving net sales and earnings in the coming quarters as well.
Valuation has room for a price rise
In the wake of the earnings season the earnings forecasts of Finnish companies for 2010 have been upgraded. According to the consensus estimate at the beginning of September, the earnings of the companies listed on the Helsinki stock exchange are expected to increase by 25% this year and by about 18% in 2011. In the light of the forecasts, the P/E ratio of the Helsinki stock exchange for 2010 is a little less than 14, while the long-term average of P/E is roughly 15. Compared to the average valuation of Western European equity markets, the valuation level of the Helsinki stock exchange continues to have a slight premium. This is partly explained by historical reasons but also by the more cyclical sector structure compared to the rest of the world.
In our opinion the valuation is now attractive and has room for a continued positive trend. Finnish equities would become expensive only if earnings growth were notably lamer than expected, and we do not find this scenario likely at present. Furthermore, the valuation of equities is low in relation to the low interest rate level. The yield on the fixed income markets is set to remain modest also in the future, which will in our view attract investors the the equity markets.
Abundant dividends in 2011?
The interim report published by the Ministry of Finance in the summer included a proposal for tighter taxation of capital income and dividends. If the proposal of the Tax Subcommittee is approved in its present form, we believe that Finnish listed companies will pay out higher dividends than usual before the legal amendment enters into force. This is what happened when the taxation of dividends was reformed last in 2005.
At present the markets expect a divided yield of 4.4% on average from the companies listed on the Helsinki stock exchange, which can be regarded as quite attractive compared to the low interest rates. Yet we do not think that the forecasts fully take account of the potential increases in dividends caused by the tax reform. Moreover, the bright dividend expectations are supported by the better-than-expected corporate earnings in H1, sustained modest investment, strong cash flows and the abundant distributable retained profits. Consequently, we expect the dividend pool available next spring to increase considerably from last year.
Considerations with share picks: emerging markets
When selecting Finnish companies, we now value a strong earnings outlook, a good market position and a moderate valuation, but also an opportunity to make acquisitions increasing shareholder value as well as potential extra dividend. We are especially interested in companies whose growth drivers come from the emerging markets. The emerging economies already account for over 70% of global economic growth, and we believe that they will continue on a path of brisk growth in the next few years. The outlook of these countries is supported by, for example, their advantageous demographic structure, expanding domestic market and plentiful natural resources.
Finnish equity investors should bear in mind that many Finnish export-driven companies also benefit greatly from the demand in the emerging countries. Such companies include Kemira, KONE, Metso, Nokia, Nokian Renkaat and Outotec, which are included in our model portfolio. We present company picks suiting the current market situation in the Finnish equity model portfolio published for portfolio service customers in Nordea's Netbank.
Tero Wesanko
Chief Equity Strategist
Nordea Asset Management
