Fears over China-related EPS risks get priced aggressively – in part overdone?
Concerns around growth dynamics outside of Europe (especially in EMs/China) and spill-over effects on European growth itself weigh on equity sentiment and the DAX in particular given its 15-20% EM sales exposure and cyclical nature. We estimate China’s contribution to DAX sales at 9% and EPS at 15% (due to higher margins, FY’14). About 3/4 of those 15% come from Autos (11.5%), while other sectors with meaningful China exposure are less relevant due to a significantly lower overall EPS contribution: Chemicals (1.7%), P&HG (0.6%), IG&S (0.5%), HC (0.4%), Tech (0.2%), Insurance (0.1%). So what’s in the price?
(1) DAX EPS – Mkt implied cuts seem overdone given our macro base case:
DAX Autos represent the index’ Achilles’ heel as their China-exposed EPS are
highly sensitive to volumes/pricing in that market. DB’s Auto team estimates
the market currently prices a 45% cut in DAX Auto EPS for 16E, which we
think may be overdone (top right chart).
So far, i) a decent credit impulse for China in Q3 (w/ +ve implications for credit
growth and in turn local car sales), ii) sequentially recovering leading indicators
(middle right chart) and iii) reassuring takeaways from our China economist on
meetings with local institutions (details) keep us from cutting DAX EPS beyond
DB’s macro base case in 15E (China GDP at 7.0% and global growth at 3.2%).
We take a more conservative stance on 16E though (global growth of 3.5% vs.
DB’s house view of 3.7%), which is in-line with considering the Auto team’s
worst case of -5% volume/pricing y/y for China’s market in 16E (details). This
equates to a 10% cut to Auto EPS and takes 3.5% off of DAX consensus EPS.
Assuming a 10% cut to other sectors with China-exposed EPS, a total 4% cut
to DAX EPS seems appropriate. This pushes our DAX fwd EPS targets lower to
860 in 15E (prev.: 865) / 925 in 16E (prev.: 950) (2% / 3% below consensus).
(2) DAX valuation – Mkt fears at odds with underlying macro data surprises:
While consensus EPS revisions in fwd estimates remained flat over the past
month post a decent 2Q’15 reporting, the DAX fell 10% over fears that China’s
growth story has come to an end, which the slump in oil prices and the
PBOC’s RMB devaluation (assumingly to counter weaker growth) may indicate.
This seems at odds with the level of relevant economic data surprises to which
changes in the DAX’ risk premium are highly correlated (bottom right chart). If
our macro case holds, then today’s 8% premium level should return to its longterm
median (7.2%) till year-end. Nevertheless, we lower our projections for a
recovery in inflation expectations and, with it, the path of lower trending DAX
fwd target PEs: Now 13.2x in 15E (prev.: 13.8x) and 13.1x in 16E (prev.: 13.3x).
(3) DAX targets: Hence, we lower our DAX YE’15E-16E index targets to 11,300
(prev.: 12,000) and 12,100 (prev.: 12,600), respectively, but remain above spot.