Shares in some of Europe’s least profitable and most indebted companies are set to outperform in the coming months if the European Central Bank starts buying corporate bonds to fight the threat of deflation.
The ECB has opened the door to the purchase of asset-backed securities such as secured corporate debt to revive economic activity in the eurozone, a move expected to give fresh impetus to a 20 per cent rally in European shares since June.
Buying corporate debt would lower borrowing costs where they are still elevated, such as in Southern Europe, bringing relief to companies struggling with high debt piles and meagre profits, such as Italian and Spanish banks and French car maker Peugeot
“The companies that tend to benefit from QE are those with very low levels of profits and high financial leverage because, ultimately, QE stimulates growth,” Francesco Curto, a strategist at Deutsche Bank, said.
He recommended screening for companies which trade at a low price compared with the book value of their assets – a sign the market is betting on a structural fall in their profits – and which also have high debt, anaemic margins and exposure to Europe’s own economy. Of the 17 companies on the STOXX Europe 600 index which trade below book value, have more net debt than equity and convert less than 15 per cent of their sales into pre-tax profit, eight are Italian banks and three are Spanish lenders, Thomson Reuters StarMine data showed.
They include Italy’s largest and third-largest lenders, UniCredit and Monte Paschi, and Spain’s Banco Popular.
Others are struggling non-financial companies with net debt two or three times the size of their equity, such as Italy’s Telecom Italia and France’s Peugeot.
Small-cap companies were also likely beneficiaries, given their higher reliance on bank loans compared with their blue-chip counterparts.
The purchase of corporate bonds by the ECB “would be quite bullish for the domestic cyclicals and probably for small caps as well, because they should benefit from a better funding environment,” said Emmanuel Cau, European equity strategist at JP Morgan.
Among the shares which JP Morgan recommends snapping up to gain exposure to economic recovery in the eurozone are motorway group Atlantia, budget airline Ryanair, Spanish lender Caixabank, and media groups Mediaset and Atresmedia – which generate almost all of their revenues in Western Europe.
While domestic shares were expected to lead a QE-fuelled rally in European shares, exporters were highlighted as longer-term beneficiaries if the euro weakens against the dollar.
Buying corporate debt would lower borrowing costs where they are still elevated
“What we’ll look at is likely to be long-term positions in ... indices and companies that get a lot of their revenue in dollars or outside the eurozone,” Arran Lamont, equity trading strategist at Citi, said.
With nearly a quarter of its sales coming from North America, Germany’s DAX is the eurozone index with the highest exposure to a stronger dollar. The index has underperformed a 25 per cent rise in eurozone blue chips in the past nine months. But “if the euro were to fall, which is something the ECB would like to achieve as well, that could also help the DAX and global exporters,” JP Morgan’s Cau said.