The brakes are being released on growth, according to data crunched by analysts at investment bank UBS. That should mean bumper profits for companies with relatively high levels of fixed costs because a greater portion of future sales should drop straight through to the bottom line.
‘This operating leverage 'kick' leads us to expect strong earnings per share (EPS) growth even on the back of modest top line growth,’ the analysts say. ‘With costs such as labour and materials still meaningfully low and companies filling spare capacity, margin expansion should be a key factor in the earnings rebound.’
Growth slow lane
In UBS’s view, the lack of inflation and real terms top line growth has been a major drag of corporate profits.
‘This seems to be changing’, say the analysts. ‘European revenue momentum has been positive for five months in a row, the longest run since 2010 - and with the return of revenue growth, we should see operating leverage kick in.
UBS points to purchasing managers index (PMI) and capital expenditure (capex) data trends to back up this hypothesis. ‘PMIs and capex investment both tend to lead margins, and we are seeing the strongest PMIs in Europe since 2010 and fixed capital formation is now the strongest since 2007.’
Who benefits
Shareholders, principally, as better than anticipated profits will likely spark raised forecasts. Improved investor sentiment towards companies that do better provides should also be reflected in higher share prices, and maybe dividends.
‘In broad terms cyclicals tend to show greater operating leverage and defensives lag,’ the analysts explain. This would imply construction companies, mining stocks and certain technology developers, yet UBS has uncovered some aberrations.
‘Household goods and Pharma also show higher operating leverage than the market.’ So we can probably expect firmer trading from the likes of Dove-to-Flora manufacturer Unilever (ULVR) and Harpic-to-Cillet Bang supplier Reckitt Benckiser (RB.). AstraZeneca (AZN) and GlazoSmithKline (GSK) are the obvious UK-listed drugs groups that could benefit.
UBS has a strong convection over building group CRH (CRH) in the construction space. It joins European names such as car maker Volkswagen, white goods designer Electrolux and German chemicals company Bayer as key operating leverage selections.
