UK plc braced for bumpy ride even though profit warnings at six year low - Ernst & Young - United Kingdom

London 24 January 2010: After an above average number of profit warnings in the first quarter of 2009, profit warnings tailed off during 2009, with 282 issued during the year, 37% less than 2008 and the lowest annual total since 2003.

There were 50 profit warnings from quoted UK companies during the last quarter of 2009, compared to 126 in 2008, a year on year fall of 60%.

Andrew Wollaston, Restructuring partner at Ernst & Young says: "Given the depth of the slump, recovery has certainly come quicker than we might have anticipated. This rapid economic recuperation, along with previously depressed earnings forecasts, is helping companies beat expectations and keep profit warnings low. Good news for UK plc, but this is not the end of the story. Rapid recovery costs and 2010 is when we start paying. Brace yourselves for a bumpy recovery."

A period of consequences

2010 looks set to be a year of contradiction for the UK economy; a year when the early optimism surrounding the return to economic growth will sit in stark contrast to looming fiscal realities. For while, extensive government and central bank intervention might have staved off the risk of depression and turned the UK economy around, such a rapid turnaround inevitably carries a high price.

Facing consequences

The start of the year should see a return to growth for the UK economy. However, that growth will be hard to sustain in the face of some strong headwinds. Budgetary constraints will necessitate not only the end of the fiscal and monetary stimulus, but that the UK government pulls back capital from the economy to help plug the gap in its budget deficit. Meanwhile, the private sector and consumer look to weak to completely fill this gap, while exports are still recovering slowing from the collapse in global demand. The end of quantitative easing (QE) will only add to the uncertainty and strain.

Keith McGregor, Restructuring partner at Ernst & Young comments: "Growth in the first part of the year could sit in contrast with economic stagnation or even a second dip later on. Either way, we are still facing the consequences of the credit crunch almost three years on. The events in Dubai at the end of 2009 amply demonstrate how quickly situations can still deteriorate. The coming years could contain more of these shocks – not as systemic or seismic as the collapse of Lehman, but still damaging and a reminder of the continuing work needed by companies to restructure and deleverage."

Outlook

The start of 2010 has seen relatively few profit warnings. The usual flurry of post-Christmas retail profit alerts have not arrived, with just eight warnings for all sectors in the first two weeks of 2010 versus 16 in the same period of 2009.

Wollaston says: "This benign start should not distract us from the obvious difficulties ahead. We can only guess at the effects generated by the end of QE but it seems unlikely that equity and debt markets can continue their stellar run without this support. If markets retreat, financing options will be fewer and more expensive in the year ahead, unless banks significantly pick up lending in 2010. At present this looks unlikely."

Profit forecasting

Profit forecasting will be less than straightforward. Economic surveys show the recovery to be fragile and vulnerable to set backs in many sectors, with a good chance that the anticipated public retrenchment could provoke a second output dip later in the year. Meanwhile, the profit warning equation – the balance between performance and expectations – will even out in the first quarter of 2010 as heavily depressed market expectations rise to meet the plethora of "better than expected" results that are already been reported.

McGregor concludes: "It will be harder for companies to beat expectations in the months ahead. If expectations become buoyed by optimism too quickly and outstrip an economy that is recovering slowly and prone to relapse, we could see a further negative imbalance and an increase in profit warnings later in 2010. How many will depend on the ability of UK plc to manage market expectations and its own internal forecasts during another tricky year."