Over-optimism seen getting ahead of Asia's actual profit recovery

By Nichola Saminather

SINGAPORE (Reuters) - Earnings expectations for Asian companies are picking up after falling for three years, but some analysts are warning that the optimism about future growth is getting ahead of the fragile recovery in actual profits.

Downgrades to earnings forecasts have been fewer and smaller since June, and there have been some upgrades, which has led to a gradual increase in profit expectations for Asia ex-Japan companies, according to data from Thomson Reuters Datastream.

The six-month percentage change in 12-month forward earnings per share fell to its least negative since June 2013 this month and many investors and analysts believe a turnaround is in the offing.

 

Consensus estimates are now for average earnings per share growth of 1.8 percent in 2016 from 2015, and 12.4 percent in 2017 from 2016 in Asia ex-Japan.

The growth expectations for 2017 indicate analysts are overestimating the pace of the recovery, which means that downward revisions to earnings forecasts could resume even as actual earnings slowly improve.

"Earnings revisions, both from three months and six months ago, are up about 5 percent," said Herald van der Linde, head of Asia equity strategy at HSBC in Hong Kong. "But earnings growth is still very low. Analysts have cut for 2016 but not for 2017, so the 2017 growth numbers are too high."

This excess could dent positive investor sentiment, which has lifted the MSCI Asia ex-Japan index almost 10 percent since the July turnaround in earnings revisions, following little change in the first six months of 2016.

"Earnings revisions indicate that a stock is improving, but not necessarily the reasons why," said Wilfred Son Keng Po, portfolio manager for Asia ex-Japan equities at PineBridge Investments. "One thing that it does indicate, however, is the fact that investors are gaining confidence in the future prospects of the company."

Overcapacity, falling bank earnings in a low interest rate environment, rising labour costs in some countries, and lower energy and commodity prices contributed to the negative earnings revisions in various sectors over the past few years, said Jian Shi Cortesi, portfolio manager for Asian equities at GAM Investment Management in Zurich.

"After a few years of challenging times, governments in Asia have been more accommodative in terms of monetary policy, and in some countries, fiscal spending is also increasing to support growth," she said. "And a lot of companies are more prudent and cost conscious, so with time, the benefits start to show."

Revisions have also slowed as, in some cases, share prices have fallen to reflect companies' true earnings, PineBridge's Son Keng Po said.

The turnaround has been led by specific markets so investors should be wary of generalizing the trend, he cautioned.

South Korea has led the improvement, thanks to strong demand for some of its hi-tech products, although Samsung Electronics' decision to abandon the Galaxy Note 7 smartphone did help dent the trend this month.

Also leading the positive revisions are Thailand, thanks to faster than expected economic growth, China, because of signs of economic stabilization and India, with its relatively strong economic growth and benign monsoons this year.

The laggards are Singapore, where banks have seen a rise in non-performing loans, and Malaysia, which has been hit by a slowing economy amid lower oil and commodity prices and weaker exports.

But even the better performers aren't out of the woods yet.

Analysts cited weaker-than-expected global growth, a strengthening U.S. dollar on expectations of rising U.S. rates, and further falls in commodity and energy prices as risks that could bring back negative revisions in some markets and sectors.

For earnings growth, and positive revisions, to become entrenched and to gain momentum, companies need to move away from the cost-cutting mentality of the past few years and start investing again, Van der Linde said.

(Reporting by Nichola Saminather; Editing by Eric Meijer)