Europe: Long-term Focus on Strong Company Balance Sheets

Corporate revenue collapse demands extensive government support: With government-mandated lockdown measures likely to last at least a few weeks, consumer demand has collapsed. Various government support measures are rightly focused on supporting stressed companies and their workers. They aim to maintain European economies’ productive capacity and workers’ spending power. In that way, governments hope to increase the chances of economic recovery once the rate of new infections and fatality eventually slows. The specific government support measures differ by country and are likely to be increased in both size and breadth over time.

Earnings decline expected: The brunt of the earnings impact may be felt in 2Q, as business and factory closures, combined with spending and activity declines, feed through into profitability. Citi analysts expect sharper downward revisions in earnings than during the Global Financial Crisis of 2008-09. While the services sectors may be particularly hard hit, Citi analysts expect manufacturers also to suffer, albeit less severely. A full-year earnings decline of 15% or worse is not inconceivable.

In the event of a weak European economic upturn, Citi analysts are likely to focus on companies that have strong balance sheets. There reasons for this are twofold:

(1) Many strong balance sheet companies also have high dividend yields, as well as strong historic growth rates in their dividend payouts. Their balance sheet strength could raise the likelihood of their maintaining dividend payouts. With interest rates likely to remain very low for some time, equities with decent dividend yields may increasingly command a premium.

(2) As well as aiding companies’ survival, strong balance sheets may also enable takeovers of weaker firms or their assets at reasonable prices.