UK profit warnings fell to a near two year low in Q2 this 2015, with UK quoted companies issuing just 57 warnings, six fewer than the same period of 2014 and a drop of 26% compared to the previous quarter.
An unexpected decisive General Election result provided greater certainty for businesses by the end of the period, whilst rising disposable incomes, low interest rates and a buoyant housing market provided sufficient economic momentum for listed businesses, according to EY’s latest Profit Warnings report.
Overall, 4% of UK quoted companies issued profit warnings in Q2 of this year, making this the lowest number and percentage of companies warning since Q3 2013. The Main Market saw a significant drop in warnings; however, profit warnings from AIM companies remained steady at 35 (4.2%) against 37 (4.4%) in Q1 2015.
The FTSE sectors leading profit warnings in Q2 were Software & Computer Services (10) Support Services (7), Electronic & Electrical Equipment (7), Media (5) and General Retailers (5).
Improving landscape but expectations could rebound too fast
Profit warnings normally tail off during the summer, but this is an especially dramatic fall in warnings given the post-crisis highs recorded in previous quarters.
Alan Hudson, EY’s head of restructuring for UK & Ireland, says, “This period was a quarter of two halves. In April, UK profit warnings again hit a seven-year high; however in May an improving global economic outlook and an unexpectedly decisive General Election result appeared to set the ball rolling on many contracts and investment decisions. This helped companies meet lowered forecasts and feel more confident about the future.
“The danger is – as ever – that expectations rebound too fast. Summer has brought renewed uncertainties and challenges. Even with helpful economic winds, there are obviously deep and enduring issues dragging on profits. Rising competition, disruptive new entrants and trends - combined with overcapacity and ‘noflation’ - provide tough conditions in which to raise prices and forecast accurately. Companies need to actively rejig their portfolios and focus on operational and capital resilience to thrive and meet rising investor expectations in this volatile environment.”
Software & Computer Services sector issues highest number of warnings
Companies in the FTSE Software & Computer Services sector issued 17 profit warnings in the first half of 2015, the most of any FTSE sector. The UK quoted sector is one of the largest and covers a diverse range of businesses. However, this volume of warnings now means that a quarter of the sector has warned in the last 12 months and recurring themes suggest that many companies in the sector lack the resilience needed to make the most of the significant opportunities that lie ahead.
The sectors’ strong international focus brings geographical and currency challenges into play. The strong dollar has dented the growth prospects of several markets, especially emerging economies. The weak euro hurts UK companies exposed to the region – and ongoing Eurozone uncertainty adds a further unsettling element. However, ‘disruptive’ areas like cloud computing, big data, smart mobility, social networking and the ‘Internet of Things’ are growing at considerably faster rates, whilst also being the key drivers for new system and application growth.
Tech winners & losers
Simon Pearson, EY technology transaction partner comments, “As in every period of rapid and significant change, some companies emerge as winners and others get left behind. A number of large technology businesses, who previously dominated their sector, have fallen by the way side in recent years. Indeed, dominance and size can be a hindrance if vested interests and over reliance and attachment to old models blinker management and inhibit their ability to adapt.”
Smaller companies should be more nimble, but many fast growing companies have heighted expectations and they are naturally vulnerable to problems with a single dominant contract. The UK profit warning data shows just that, with all but one of the 17 warnings issued this year coming from companies with a turnover below £200m.
Continuing, Pearson says, “Companies can’t afford to stand still in this sector. Where possible they should think about broadening their client base by market and geography, but beyond that it’s vital to apply best practice in understanding and managing risk across the contract lifecycle. This includes building in flexibility to counteract the risk from wage inflation and volatile exchange rates and also effective and regular monitoring of contract performance to ensure management receives early warning of any issues. Companies should also be applying robust cash forecasting across projects and divisions in order to ensure adequate liquidity and working capital.”
Swings and roundabouts for retail
FTSE General Retailers issued five profit warnings in Q2 this year, taking the first half total to 11 – the highest since 2011. The recent macro-economic environment appears to offer every advantage but this hasn’t been enough to cushion some retailers against a costly battle to keep pace with changing consumer behaviour and the equally constant demand for low prices.
The profit warning data suggests sector health remains mixed, with over 25% of General Retailers warning in the last year. By sub-sector, apparel is by far and away the sector under most stress – representing half of all FTSE General Retailers warnings issued this year.
Jessica Clayton, EY transaction advisory services partner and retail specialist, comments, “What’s preventing the macro picture from translating into a healthier sector? In many cases, it is the continuing price-investment conundrum. Consumers are sticking to behaviours adopted during the recession - they have become comfortable with shopping with the discounters and diverting any spare cash to treats. Consumer spending on eating out has risen and the high street has serious competition for the consumer pound.”
This focus on price has made consumers no less demanding, they are still looking for value and for seamless service across all channels. Keeping up with the latest shifts in technology and related changes in behaviour is placing increasing demands on investment, working capital and on the finance and buying functions. These strains – and need for additional investment - become especially apparent in the long run into Christmas, starting with the peak of Black Friday.
Clayton adds, “Retail as a whole has become a much fitter and leaner sector in the last seven years. Companies with operational and capital flexibility – and the ingenuity - to adapt should still be able to thrive by harnessing new opportunities. New technologies, new partnerships and changing store profiles will offer new ways to interact with consumers. However, some retailers won’t have the ability or capacity to reinvent themselves fast enough. The strains of under-investment and financial inflexibility become particularly apparent as buying patterns display more pronounced peaks and troughs. The next six months could further sort the resilient from the vulnerable.”
Alan Hudson, concludes, “This is a year of contrasts and contradictions. Stronger growth and rising deal activity stand in sharp contrast to the Eurozone’s growing existential crisis and rising emerging market concerns. The contrast between these narratives, combined with heightened monetary policy speculation, has increased market volatility and clouded the outlook for the second half of 2015.
“A rebound in growth and deal activity should remain the dominant theme for 2015. But the recovery will have less speed and stability if uncertainties continue and create a more testing period for UK companies and their earnings forecasts. But for UK earnings the macro environment is only part of the story. Whatever fair and foul economic winds are blowing, many companies are also still contending with dizzying change within their own sector, as disruptive entrants and technologies continue to challenge pricing and old models. Change always brings opportunity, but only for those resilient enough to take advantage.”
Source - EY