European Slowdown Hurting U.S. Multinationals

EVEN AS THE domestic economy has suffered, Europe has been a reliable source of earnings power for U.S.-based multinationals, thanks to a weak dollar and unflagging expansion. But as the effects of the financial crises plaguing America slowly ripple across the Atlantic, shareholders in these globally dependent companies are finding their investments may be in jeopardy.

Tobias Levkovich, chief U.S. equity strategist for Citigroup, sounded a clarion call in May. He pointed out that many blue-chip U.S. companies rely heavily on overseas profits, particularly from the developed markets of Western Europe, to keep notching earnings growth.

"The reality of large European sales exposure for U.S. companies cannot be ignored if business trends are sliding," he wrote. "By our estimates, just under half of U.S. companies' international sales occur in all of Europe, which likely has serious implications for a number of industries and companies."

According to Levkovich, the most vulnerable sectors are technology, auto parts, pharmaceuticals and consumer goods. Microsoft (MSFT) and Hewlett-Packard (HPQ) each get more than 40% of annual sales from European markets. Johnson Controls (JCI), the car-parts marker, saw 38% of its sales in Europe. Europe brings in 30% of DuPont's (DD) sales and 37% of Dow Chemical's (DOW) revenues. Procter & Gamble (PG) and Colgate-Palmolive (CL), global consumer brands, get 30% and 27% of sales from Europe, respectively.

Over the past three months, all of those stocks have declined in value; most have fallen faster than the broad market. While there's no single explanation for the selloffs, weakness in European markets — until recently a source of steady, reliable growth and cash flows — is among the culprits.

Many developments point to Europe's economic woes, including drops in new orders among businesses and a two-year low in German consumer confidence. Last week, Eurostat, the European Union statistics agency, cut the year-over-year GDP growth figure for the first quarter in the 15 eurozone nations to 2.1%, down from an earlier estimate of 2.2%. Growth has been tapering off steadily over the past four quarters. European Central Bank President Jean-Claude Trichet's remarks before tightening interest rates in July added to the anxiety.

"There was a fairly aggressive, 'We're not messing around' type of tone to his remarks, and that creates incremental pressure," Levkovich says.

Connie Maneaty, a consumer products analyst who covers Colgate and P&G for BMO Capital Markets, says if the dollar stays at its current rate of around $1.59 to the euro, inflation on the Continent will start to make dollar-denominated purchases less of a bargain. That could happen as soon as the fourth quarter, she says, shrinking currency-derived earnings increases for U.S. companies.

"It's pretty safe to say we're not raising estimates for the multinationals any time soon," Maneaty says.

The European Central Bank's 25-basis-point interest rate hike earlier this month was the first time it had raised interest rates in a year. Putting the key rate at 4.25% reflects serious concerns about inflation in the 15 countries that use the euro, says Mark Warnsman, an analyst at Calyon Securities.