Falling profit warnings are as much a measure of fear as confidence, says EY report

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Sectors with greatest proportion of companies warning included Construction & Materials General Retailers, Media and Software & Computer Services

London July 9 2012: UK profit warnings fell 18% in the second quarter of 2012 but the drop was as much to do with reduced expectations, falling input prices and companies battening down the hatches, as it was improving trading conditions.

According to EY’s latest Profit Warnings report, UK quoted companies - Main Market and AIM listed - issued 60 warnings in Q2 2012 just below the 64 issued in the same quarter of 2011 and 13 fewer than the previous quarter of this year.

Those companies issuing a high number of warnings are those facing strongest headwinds of falling demand, tightening finance and the quickening technological changes that are revolutionising the way companies relate to their customers.

The FTSE sectors with the greatest number of companies warning were Construction & Materials (7), General Retailers (5), Media (5) Software & Computer Services (5) and Support Services (5).

Warnings drop but slow growth and persistent uncertainty lingers
Alan Hudson, head of EY’s UK & Ireland restructuring practice, said, “Part of the fall in warnings is undoubtedly due to a slight improvement in trading conditions, alongside hopes for an Olympic boost, and, crucially, falling input prices. However, many companies have also battened down the hatches and cut costs to meet targets, while recent peaks in profit warnings and increased Eurozone turbulence have also drastically reduced expectations in many sectors.

“Even if the UK economy moves back into the black this summer, the recovery still lacks the traction it needs to build sustainable momentum. There is only so much fat that companies can trim and only so long they can tread water with little or no investment – investment that both they and the UK economy desperately need.”

Cracks appear in the construction sector
Most FTSE sectors saw a year-on-year drop in profit warnings in Q2 2012. The main exceptions to this downward trend were those sectors with companies affected by the most substantial economic and structural difficulties caused by changing spending patterns and the impact on credit, confidence and key export markets caused by the ongoing Eurozone crisis.

The FTSE Construction & Materials sector led profit warnings in Q2 2012 and issued its highest number of alerts since the credit crisis in 2008. The impact of contracting credit, falling confidence, fiscal tightening and the PFI hiatus have been building on the sector for some time, as illustrated by the 41% of FTSE Construction & Materials companies warning in the year-to-date.  Hope lies in promised infrastructure investment, but that will take some time to take positive effect, especially if the funding environment remains problematic.

Keith McGregor, head of restructuring for Europe, Middle East and Africa, said, “The FTSE Construction & Materials sector is experiencing its toughest period since the financial crisis. Improving order levels and infrastructure opportunities offer hope. However, the benefit of rising new order levels won’t be felt until 2013 and there is still uncertainty surrounding the timing of public spending, while financing uncertainties limit private sector expansion.”

It’s raining again... on the high street
The perennial struggler, the General Retail sector, is still feeling the pressure of rapid change and constrained consumer spending, with the unwelcome complication of unseasonal weather. Falling inflation and this year’s festivities provide an opportunity to increase sales, however, wage rises remain behind price rises and consumers with limited resources could just promote and defer buying, without actually spending much more.

Hudson adds, “Even if the summer’s festivities do provide retailers with a welcome fillip, many will still struggle and the successful ones will be those who are financially fit, operationally excellent and who continually adapt their multi-channel strategy to lure customers.”

Accurate forecasting proves difficult
Looking forward, the second half of 2012 could offer mixed blessings for UK plc.  On the upside, falling input prices and inflation should improve profit margins and start to take the pressure off the UK consumer. However, set against this are the effects of continuing uncertainties of the Eurozone crisis, fluctuating consumer and market confidence, uncertain access to credit and an uncertain path for the UK economy as it struggles to escape the slow lane.

McGregor concludes, “It would be tough enough to make accurate forecasts in this environment, but companies also have the unseasonal weather and the impact of the summer Olympics to add into the equation.

“Profit Warnings are unlikely to rise significantly, unless there is a further negative jolt to the economic outlook or a further escalation of the Eurozone crisis. A slow and difficult recovery is now pretty much “built in” into current profit forecasts due to an almost continuous flow of bad news and the spike in warnings towards the end of last year and beginning of this.”

Download Profit Warnings Q2 2012 1.3Mb, July 2012