Profit Warnings fall as businesses and analysts downgrade expectations

Retail and Construction sectors bear brunt of weakening economy

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London 9 October 2011: Profit warnings from UK quoted companies dropped significantly in the third quarter of 2011; but diminished expectations, rather than economic improvement is behind much of the fall, according to EY’s latest Profit Warnings data.

UK quoted companies - Main Market and AIM listed - issued 51 profit warnings in Q3 2011, 11% more than the same quarter of 2010 (46 warnings) and 28% fewer than were issued in Q2 2011 (64 warnings).

Alan Hudson, head of EY’s UK restructuring practice, says, “Undoubtedly, part of the drop is due to limited growth in the UK economy which, when combined with operational efficiencies, is helping companies to meet profit expectations. However, it is also true that these profit expectations have been scaled back significantly over the summer, hit by escalating fears of a double dip.”

Retailers share their pain with construction
The FTSE sectors with the highest number of profit warnings this quarter were General Retailers and Media with six, and Software & Computer Services and Construction & Materials with five.
 
UK retailers face their biggest test since 2008. Quoted Retailers have already issued more profit warnings in the first nine months of 2011, than in the whole of 2010 and 2009 combined, and will be approaching Christmas with more than the usual mixture of hope and trepidation. Keeping a tight rein on stock and cash levels will be vital in the lead up to Christmas and the December quarter rent day.

Hudson comments, “As we move into the vital final quarter, profit will come second to cash flow concerns for those retailers who have already dug deep into their reserves to put stock on the shelves and pay the rent. Some are clearly running on empty and desperately need tills to start ringing quickly.
“Some in the sector are clearly up against it as competition and pricing intensifies and the consumer remains cautious. Retail insolvency usually peaks in January, but there is danger that we might see further retailers fail in the final months of 2011 as they run out of cash.”

Construction & Materials was the FTSE sector with the highest proportion of companies warning this quarter, with 15% of companies warning in Q3 and 24% in the year-to-date. 
“The long construction pipeline has delayed the impact of the slowdown and austerity in the sector, but cracks are now starting to show. The pain is focused mainly at the small to medium end, where there is less of a buffer against contract loss,” Hudson adds.

US recovery and eurozone crisis adds uncertainty
The economic outlook at the start of 2011 appeared to be improving, but there is clear potential for the UK’s economic situation to turn ugly again. Domestic growth is weakening, whilst a waning US recovery and the escalating eurozone debt crisis present a further threat to both capital and growth. Not least because governments and central banks have far less firepower than in 2008.

Keith McGregor, EMEIA restructuring partner at EY comments, “With the largest domestic GDP contributors ex-growth and its biggest trading partners spluttering, the UK economy needs the private sector to invest the cash it has kept on the sidelines for the past three years. But in the face of such uncertainty, there is a danger that businesses continue to hold back and, unless confidence returns, the UK economy could stall for some time to come.”

Volatility turns forecasting into a guessing game
There is still some debate as to whether analyst profit downgrades have gone far enough in some sectors. Commodity pricing pressures appear to have eased, but the impact of currency movements still make for an extremely volatile and unpredictable environment.

But the biggest risk in terms of demand and currency volatility comes from the eurozone where the endgame is still impossible to predict.
McGregor concludes, “Given the increasing economic worries at home and abroad, many UK quoted companies have been exceptionally cautious in their recent outlook statements.  This means a tough 2011 and an austerity Christmas is priced in for most quoted UK companies and even a flat final quarter could result in a only a modest year-on-year rise in profit warnings.

“However, events could easily overtake forecasts, especially for those heavily exposed to the beleaguered peripheral economies of the eurozone and those serving the consumer, where confidence rests on a knife-edge.”

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