Stock markets around the world well and truly entered the summer doldrums in July. Since the start of the month, the major indices in Europe and the US have fallen by about 5 per cent. This poor July performance has driven the year-to-date equity market returns firmly into negative territory.
In the US, the S&P 500 is down by 2.5 per cent while the Nasdaq has fallen by 8.5 per cent. In Europe, the FTSE 100 index is down by 4.2 per cent, although the Europe-wide FTSE Eurotop 300 index is now unchanged so far this year.
By the standards of the 2000-2002 bear market, these are modest declines in share prices.
Interestingly, the first half's lacklustre equity markets stand in sharp relief when set against the trends in corporate profits. These have been growing very rapidly for more than a year and are expected to continue to grow for at least the next 12 months.
The combination of flat to slightly declining share prices and rising profits has resulted in a significant improvement in equity valuations. This is particularly true for the highly rated US market, where corporate profits are growing at an annual rate of more than 20 per cent.
The most commonly used valuation yardstick is the price-earnings ratio (PER), which for the US market has been well above 20 for most of the past decade. It is currently trading around 18 and, if profits keep growing rapidly, the PER would decline to 15 in the coming 12 months if share prices were to remain static.
A similar dynamic is occurring in the Irish market, where corporate earnings are growing faster than the rise in share prices. At first glance this may not seem to be the case, given the 8 per cent rise in the ISEQ
Overall index year-to-date. However, if the stellar rise in Elan Corporation is stripped out, the Irish index falls back into the pack with a 2 per cent year-to-date gain.
Given this market background it is perhaps not too surprising to find that the two newcomers to the Irish market this year - Eircom and C&C - have found the going very tough.
Of the two, C&C has fared better, with its share price managing to make some headway post flotation. In contrast, the Eircom share price immediately traded at a small discount to its issue price of €1.55 and has remained below that price ever since.
Although these companies operate in entirely different businesses, from an investment perspective there are several similarities. Both offer an above-average dividend yield with C&C's very attractive 5 per cent yield surpassed by Eircom's mouth-watering yield of well over 7 per cent.
There are, however, question marks regarding the capacity of Eircom to generate enough free cashflow to sustain this dividend while analysts expect only modest increases in C&C's dividend over time.
In part, these worries are due to the high levels of debt carried by these companies. This is particularly true of Eircom, which needs to use as much of its free cashflow as possible to invest in capital equipment and to make some inroads in its mountain of debt.
Both companies operate in highly competitive markets and both are heavily dependent on the Irish economy.
C&C can best be described as a beverage group with a small snack division. It is the leading cider manufacturer and shares the top market slot in soft drinks and snacks. It is still too early to judge whether the smoking ban will adversely affect sales, although any negative impact so far seems to have been quite limited.
For C&C, its main avenue of future growth lies in its success in growing its international cider sales. Currently, about three-quarters of its profits are generated in the Republic and the scope for domestic growth does seem to be quite limited.
Eircom is faced with a different set of challenges. It is likely to remain the dominant player in the Irish telecom market due to its position in the fixed-line market. It has about 1.9 million fixed-line access channels and it is also the Republic's largest internet service provider (ISP) with in excess of 500,000 subscribers.
However, call volumes and pricing will remain under pressure from both wireless substitution and competitive threats. The company should be able to offset most of the negative impact on profits from these threats through the roll-out of new offerings such as broadband.
In time, Eircom is also likely to re-enter the mobile phone market as a virtual operator. Using this model it would effectively rent capacity from another operator and brand a new Eircom mobile offering.
If both these companies can deal effectively with their respective competitive threats, their businesses should benefit from the strong Irish economy, which should ultimately be reflected in improved share prices.
