Fall in profit warnings reflects improving economy and confidence, says EY report

22 July 2013

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  • UK quoted companies issued 54 profit warnings in Q2 2013, six fewer warnings than the same quarter in 2012 and 18 fewer than the previous quarter
  • Q2 2013 also saw the lowest number and percentage of companies warning in a second quarter since 2010, at 51 and 3.8% respectively
  • Retail and Construction sectors show some signs of improvement
  • A more benign economy should keep the number of profit warnings low, but below par growth will continue to create challenges

Profit warnings from listed businesses – both AIM and Main Market companies – fell to their lowest level since 2011 in the second quarter of this year, as the UK economy continued to gain momentum.
Profit warnings normally fall back in the second quarter, but the 25% quarter-on-quarter fall  from 72 to 54 – the largest in four years – reflects a significant upwards shift in economic activity and renewed confidence, according to EY’s latest Profit Warnings report.

This confidence is evident in the significant number of companies still confident of hitting full year profit targets, despite reporting results well below expectations at the start of 2013.

Q2 2013 also saw the lowest number and percentage of companies warning in a second quarter since 2010, at 51 and 3.8% respectively. Sectors with the highest number of warnings were FTSE Software & Computer Services (7), FTSE Travel & Leisure (6) and FTSE Electronics and Electrical Equipment, FTSE Media and FTSE Support Services, (all with 5).

Is this confidence justified?

Keith McGregor, EY’s head of restructuring for Europe, Middle East and Africa, says, “The UK recovery certainly appears more entrenched and better placed to ride out the aftershocks that have triggered sobering second half dips in economic activity in recent years. That said, the economy still faces significant domestic challenges, especially from inflation. A stagnant Eurozone and cooling emerging markets also look likely to place a speed limit on growth.

 “A more benign economic climate should keep the number of profit warnings low, but below par growth will continue to create challenges. Companies should still be flexing their operating and financial structures to adapt and make the most of what is still a relatively modest recovery.”

Retail conditions improve but administrations bring chill to the sector

Companies in the FTSE General Retailers index issued just two profit warnings in Q2 2013, three fewer than the five issued in the previous quarter and the same quarter of 2012 – the lowest level of warnings from the sector since 2010. Apparel companies feature significantly in both the quarter’s administrations and in the previous 12 months of profit warnings, when almost a third of alerts from FTSE General Retailers came from apparel companies.

It certainly looks like a better environment in 2013, with consumers buoyed by record levels of employment and an improving housing market, but retailers still face significant challenges.

Alan Hudson, EY’s UK & Ireland head of restructuring, explains, “A rash of retail administrations, focused around last quarter’s rent day, suggests several parts of the retail industry are struggling in this ultra-competitive environment.

“Struggling retailers appear to share operating characteristics, rather than products.  These include excess physical space, weak brands, low differentiation as well as the inability to compete with increasingly aggressive competitors on product and price.  Although, amidst the relentless change, some things remain constant - the need to get the basic proposition right and give the customer what they want when and how they want it.”

Construction builds from the bottom

Companies in the FTSE Construction & Materials sector issued three profit warnings in the second quarter of 2013, up from two in the first quarter of the year. However, this is four less than the seven alerts issued in the same quarter of 2012, when profit warnings from the sector equalled their credit crunch high. A year on, construction output finally appears to be stabilising and even improving in some places.  The construction industry is highly correlated to GDP growth and this momentum should continue to build in 2013.

Hudson says, “Construction activity should continue to improve in 2013 if GDP continues to rise. Recent trading updates from industry bellwethers are certainly more upbeat. However, the industry is recovering from a low base, orders are still well below historic averages and pipelines aren’t built overnight.

“In the recovery, as in the recession, it is vital that companies get the operational and financial basics right, from a focus on cash to the development of strong collaborative relationships.  The on-going price squeeze has focused the minds of construction management teams on operational and cost efficiencies. These leaner companies should now be best equipped to make the most of the upturn in demand.”

The future’s bright but it’s far from plain sailing

The UK economy is building up a head of steam. Economists are upgrading their forecasts, confidence is growing and companies are issuing fewer profit warnings.

McGregor errs on the side of caution, “The recovery is no stranger to false dawns and profit warnings have followed this pattern, dropping to historic lows, only to spike back up as recovery hopes are dashed. 

“The current level of momentum and support should guard against a repeat of previous summer setbacks.  Nevertheless, although there are patches of blue, it is hardly a cloudless sky. Domestic and external challenges look set to limit the rate of growth and the UK economy is still a long way short of its pre-crisis level of activity. It is a brighter outlook, but the recovery has a few years yet to run.”

Read Analysis of Profit Warnings Q2 2013 739K, July 2013