Profit warnings hit a six year low

But confidence should not turn to complacency

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11 October 2009: UK profit warnings hit a six-year low in the third quarter of 2009. There were 52 profits warnings from quoted UK companies during the Q3 of 2009. This is a year on year drop of 53%, and 17% less than the second quarter this year.

Keith McGregor, restructuring partner at EY said: “This dramatic fall is due to a complex mixture of previously withdrawn company guidance, already depressed market expectations and an improving economic outlook that has encouraged companies to look ahead with greater confidence, with the worst of the downturn seemingly past.

“Nevertheless, confidence should not turn to complacency. The one-off effects of monetary and fiscal stimulus and inventory rebuilding have put a gloss on current demand that could soon tarnish once this support is withdrawn. The ability of the economy to transition smoothly from this temporary boost to self-sustaining growth is still in serious doubt given the strong headwinds from still tight credit and the ongoing effects of balance sheet restructurings in both the private and public sector. Relapses are still possible, a slow recovery probable. The worst of the downturn may be behind us, but that does not mean all the risks to UK plc are too.”

A fragile economy
Just over a year since the collapse of Lehman Brothers and, against the odds, clear signs of life visible in all major economies, with most expected to be out of recession by the end of 2009, this will be a remarkable turnaround and much quicker than many expected. So is this an argument for a V-shaped recovery?

Andrew Wollaston, restructuring partner at EY commented: “This optimistic scenario is compellingly attractive, but unfortunately unlikely. We certainly appear to have reached the bottom of the cycle quicker than expected, but it does not necessarily follow that the recovery will come faster than expected too.

“While today’s challenges may appear less pressing than those faced in 2008, they are equally stern. A long period of weak growth will weigh heavily on results and confidence and chip away already dented balance sheets.”

Sector focus – Travel & Leisure
A succession of shocks from the 1990s recession through to the impact of 9/11 and SARS has toughened the travel and leisure industries, which came into the recession in reasonable shape. Nevertheless, the depth and scale of this downturn, when combined with the credit crunch, set even greater challenges for the sector. In the last year, one fifth of FTSE Travel & Leisure companies have issued a profit warning, reflecting not just pressures on consumer spending but also a succession of specific structural and cyclical obstacles that has tested each sub-sector’s mettle in the face of high, rigid fixed costs.
Wollaston said: “One structural change in particular ensured that pubs, bars and nightclubs felt the impact of this downturn quickly, with the smoking ban rapidly exposing weaknesses. The worst of the shocks to the income statement appear to have passed. Pub and bars profit warnings have fallen from a five-year high of seven in 2007 to just two so far in 2009.

“The continued impact of the smoking ban, continuing supermarket competition, rising unemployment and another poor summer and still stretched balance sheets could yet trigger further restructurings. Over 50 pubs are still closing each week, many sites bought for extraneous developments still lie empty, wet laden pubs are still struggling and food-led pubs are not immune, with the amount of Britons spending on informal eating out falling for the first time in forty years.”

Previously high levels of profit warnings have severely subdued market expectations, for the companies who have warned and for their peers. The low number of warnings we see in the rest of 2009 may be as much due to depressed expectations as a budding recovery. However, if expectations become buoyed by optimism too quickly and outstrip an economy that is recovering slowly and prone to relapse, then we may see a further negative imbalance between expectations and results, leading to a higher number of profit warnings later in the year.

McGregor concluded: “The next wave of restructurings may well come in the next two quarters when companies begin reporting a full year below-average growth, which will sorely test covenants at a time when banks will have rebuilt capital and will have their attention focused on sifting the winners from the losers.”

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