Highest first quarter profit warnings since 2011 despite economy gathering momentum

28 April 2014

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  • UK quoted companies issued 74 warnings in Q1
  • Strengthening pound, weakening emerging markets  and pricing pressures dominated warnings
  • Companies in the FTSE 100 issued 14 warnings in Q1 2014 – more than at the height of the financial crisis

The economy picked up speed in first quarter of this year but so did the number of profit warnings, with UK quoted companies issuing 74 warnings in Q1, one more warning than the previous quarter and the highest first quarter total since 2011.

UK earnings expectations ran too far ahead last year, dropping back by the end of 2013 and falling dramatically again in Q1 2014. While domestic demand is improving, anxieties over emerging market economic performance, concerns over the strengthening pound and pricing pressures from cost conscious customers continue to lower profit expectations  – according to EY’s latest Profit Warnings report.

The strengthening pound and weakening emerging markets dominated  profit warnings in Q1 2014, with just over a quarter of warnings citing adverse exchange rates, against an average 3% in the previous four quarters. Just shy of  20% companies cited ‘pressure on pricing’ in their profit warning, compared with a five-year average of  6%.

Companies in the FTSE 100, most exposed to emerging markets and with high foreign currency exposure, issued 14 warnings in Q1 2014 – more than at the height of the financial crisis. FTSE sectors issuing the highest number of profit warnings in Q1 2014 were FTSE Support Services (12), FTSE Food Producers (5) and FTSE General Retailers (5).

Economy improves but profit forecasts fall

Keith McGregor, EY’s Capital Transformation Leader for Europe, Middle East, India and Africa, says, “The pace of UK profit warnings continued unabated in the first quarter of 2014, with expectations coming under pressure from a number of quarters. The UK recovery remains in full swing, with vital global markets also growing. However, UK profit forecasts are still falling in response to growing pains in developing markets, the strengthening pound and pricing pressures closer to home. 

“Despite these concerns and the increasing tension between Ukraine and Russia, market anxieties largely eased during the first quarter. This is due in good part to investors’ quest for yield in an increasingly low return environment – a quest that has seen investors take on more risk in search of greater reward. While the economic backdrop should continue to improve in 2014, it will be far from plain sailing for UK plc.”

Retailers can look forward to happier days ahead

The consumer outlook is improving, buoyed by a pick-up in the housing market and the anticipated boost from a further fall in unemployment and a long awaited rise in real incomes. While retail surveys still show volatile sale patterns against a backdrop of falling prices, non-food retailers are largely managing well in this environment.

FTSE General Retailers issued five profit warnings in Q1 2014, up from two last quarter and equal to the same quarter of 2013. A small group of companies has contributed to many of these alerts and the proportion of retailers issuing profit warnings now stands at a four-year low.  In the year-to-date, just 14% of the FTSE General Retailers sector has issued a profit warning, the lowest rolling 12-month figure since the start of 2010.

Alan Hudson, EY’s head of restructuring for UK & Ireland, comments, “This is a further indication of increasing sector resilience and the improving consumer backdrop, with rising market confidence underlined by a string of successful retail IPOs.  Although, it’s certainly not going to be a completely smooth ride for retailers and it may be tough to live up to some heightened expectations in what still is a highly competitive and changeable consumer environment.

“The improving sector outlook and investor interest in the sector provides all retailers with a platform and a window to develop their business and rationalise their portfolio. Companies should be looking to take operational measures to get ready for growth and ensure their businesses are flexible enough to face the future.”

Tension in food retailing squeezes food producers

Increasing tension in UK food retailing and volatile emerging markets will keep the pressure on FTSE Food Producers, who issued five profit warnings in Q1 2014 - the highest quarterly total since 2006.  Food Producers are still feeling the pressure from slower than expected growth in emerging markets and intense competition in mature sectors, with pricing pressures prevalent throughout. 

Hudson adds, “The attraction of emerging markets stems in part due to difficulties closer to home, where the level of competition and pressure on pricing remains intense. The UK consumers’ focus on value and convenience continues to polarize and reshape the food retail market, with shoppers flitting between online, discounters and premium supermarkets and using local stores.

“This shift in consumer behaviour has left the big-four supermarkets defending falling market share. They’ve largely chosen do to this through price, prompting concerns of a further price war. The big four supermarkets still command a huge share of the UK food market and manufacturers will undoubtedly find themselves in the crossfire. 

“In response to these pressures, food companies have been streamlining their businesses, focusing on productivity and trimming their business down to their core products. In emerging markets, the focus is less on top-line growth and market share and more on bottom-line profitability.”

The future’s bright but challenges lie ahead

Concluding, McGregor said, “Confidence has clearly returned and the economy is moving to a stronger position but the rest of 2014 looks set to bring new challenges that will continue to test earnings forecasts and raise questions of risk and reward in capital allocation.

“Businesses will need to think carefully about capital needs and allocation in the next 12-18 months and how they will achieve growth in this environment, either through efficiency savings or transactions. For those with the means to do deals, portfolio rationalisation and quality, over quantity, are key deal trends as companies take cautious steps forward.

“There will be more twists and turns as markets anticipate the first steps towards monetary policy normality in the UK and US. Low inflation may delay interest rate rises until mid-2015; however, central banks have a fine line to tread between supporting recovery and encouraging hubris. This shifting capital landscape provides more options for investors and stakeholders, and companies will need to be operationally and financially fit to compete and capitalise on the recovery.”