Analysis of UK Profit Warnings Q4 2014

26 January 2015

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Profit Warnings

  •  299 profit warnings issued in 2014 versus 255 in 2013 – highest number since 2008
  •  FTSE 100 companies issue more warnings in 2014 than height of financial crisis
  •  FTSE sectors vulnerable to contract disruption led profit warnings - Support Services (47), Software & Computer Services (28) and Media (16)

Profit warnings hit a six-year high of 299 in 2014, with more FTSE 100 companies warning in 2014 than at the height of the credit crunch, according to EY’s latest Profit Warnings report.

But it wasn’t just the FTSE 100 that issued the lion’s share, total profit warnings from FTSE 350 companies were just three shy of the record 90 issued in 2008. While there is an increase in ‘serial’ profit warnings within 2014’s total; the proportion of companies warning has also increased significantly - rising from 14.7% in 2013, to 16.3% in 2014.

Adverse exchange rates, in particular a strong pound and weakening emerging market currencies, were cited by 17% of those companies warning in 2014, including 27% of warnings from the more internationally exposed  FTSE 350.

Throughout 2014, 20% of warnings cited contract delays or cancellations, peaking at 27% in Q4 2014 as global uncertainties increased. FTSE sectors vulnerable to contract disruption led profit warnings in 2014 included Support Services (47), Software & Computer Services (28) and Media (16).

Improving economy  no longer a guarantee of a smoother ride for UK plc

This rise in profit warnings – 299 in 2014 compared to 255 in 2013 - is more consistent with a period of low growth or global shock than an improving macro outlook. Many companies have faced increasing challenges to their forecasts in recent months from rising geopolitical concerns and falling oil prices.

Alan Hudson, EY’s head of restructuring for UK & Ireland , says, “The six year high in the number of profit warnings appears incongruous given that UK and global economic outlooks still signal growth, but increasing political, policy and pricing uncertainties conspired to hit confidence at the end of 2014.

“However, many of these pressures represent new realities, rather than a passing phase. An improving macro outlook is no longer a guarantee of a smoother ride for UK plc. To avoid being at the mercy of events  - and to improve investor communications - companies need to take the initiative, build operational and capital resilience and adapt their forecasting and planning capabilities to the post-crisis economy.”

Black gold loses its shine

Four companies in FTSE Oil & Gas sectors have already issued profit warnings in the first three weeks of 2015. It is a significant number, but the pressure was on before the oil price plummeted.  A quarter of the FTSE Oil Equipment Services & Distribution sector warned in 2013 and again in 2014, with most of these warnings coming in the first half of the year.

The recent rapid price fall has compounded existing capex pressures, increasing stress for contractors and suppliers.

Hudson adds, “Life wasn’t easy at $100 a barrel. The recent dramatic fall in the price of oil - if sustained – will continue to result in radical action upstream to defend returns. That fight was already underway and $50 oil will act as a powerful catalyst. There’s little doubt that we’ll see further industry restructuring as business models adjust to new realities in activity and pricing. The industry should emerge leaner and fitter, but there’s a difficult period of adjustment to come.”

Black Friday boost for retailers?

The retail sector had an eventful 2014, from the IPO boom to a game-changing Black Friday and a seismic year for grocery. FTSE Food & Drug Retailers companies issued eight profit warnings in 2014 – the highest recorded since the EY Profit Warnings report began in 1999. In contrast, just 14% of FTSE General Retailers companies warned in 2014 – a record low.

Jessica Clayton, EY transaction advisory services partner and retail specialist, said, “The disparity is stark and has parallels to the mid-2000s, when structural changes pushed profit warnings from general retailers to record highs, whilst warnings from food retailers hit record lows. Arguably the grocery sector is now undergoing a similar revolution, with disruptive new entrants, online adoption and changing consumer behaviour exposing weaknesses and overcapacity and compelling exposed retailers to take radical action.”

Retail sales data confirms that Black Friday did bring consumers out in droves. However, profit numbers may tell a very different story to the sales data. Some question whether it is in the sector’s best interests to focus so much trading on one discounted day so early in the season.

Clayton adds, “Once retailers had discounted, it was also hard to revert back to full price.  The extreme peak in sales placed significant pressure on retailers’ infrastructure, particularly in fulfilment, with third party delivery services also struggling to cope. To avoid similar issues next year, retailers will need to make considerable investment across all of their channels to meet the challenge. This begs the question: ‘Is it worth it?’ However, the question may be moot, as it will be hard to put the genie back in the bottle.” 

Business resilience holds the key to future success

Concluding, Hudson says, “It’s been a breathless start to 2015, full of surprises and volatility. The underlying forecast is for improved, albeit below par, growth, boosted by cheaper oil.  However, the low oil price isn’t without complications and it’s not enough to compensate for weaknesses elsewhere, which look set to dampen confidence and limit global investment and consumption yet again. This mixed global outlook – and a relatively strong pound - will leave the UK economy once again reliant on domestic momentum in 2015.

“There are clear advantages in these uncertain times for companies who can take the initiative and demonstrate resilience in the face of economic and market volatility. Stakeholders are increasingly looking at how companies’ operational and capital structures measure up against market stresses and how well they understand changing sector dynamics. Companies will need to demonstrate clear vision and the ability to adapt to new realities. These pressures aren’t going away.”