Profit warnings down in the first quarter of 2016 but still remarkably high given substantial downgrade in expectations, reveals EY report

24 April 2016

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  • UK quoted companies issued 76 profit warnings during Q1 of 2016
  • High proportion of companies warning - in the twelve months to the end of Q1 16, 17.2% issued warnings
  • Companies blame oil prices, volatility competition and sector disruption

UK quoted companies have issued a remarkably high number of profit warnings given the substantial downgrade in profit expectations at the end of 2015, according to EY’s latest Profit Warnings report. UK quoted companies issued 76 profit warnings during the first three months of this year – down from 77 in the same quarter of 2015 and 24 fewer warnings than the previous quarter.

Weak oil prices once again featured highly, but that is not the only factor denting expectations. The volatile start to 2016 created uncertain and difficult conditions for companies reliant on the contract cycle. Central bank action has soothed market concerns, but the global economy is still struggling to build momentum. Meanwhile, companies are clearly still coming to terms with the intense competition that comes as a result of overcapacity and disruption across many sectors.

There are still a relatively high proportion of companies warning. In the twelve months to the end of Q1 16, 17.2% of UK quoted companies issued profit warnings compared with 16.5% at the same point in 2015.The FTSE sectors leading profit warnings in Q1 16 were: Support Services (9), General Retailers (8) and Media (7). The FTSE sectors with the highest percentage of companies warning in the year-to-date are: Oil Equipment, Services & Distribution (50%), Mobile Telecommunications (50%) and Electronic & Electrical Equipment (50%).

Resilience and flexibility are vital                     

Alan Hudson, EY’s head of restructuring for UK & Ireland, comments, “Resilience and flexibility remain vital in these markets and we expect to see companies maintain their focus on operational improvement, and on capital and portfolio management. Outside a major shock, a further dive in expectations makes a further profit warning peak unlikely. However, the level of profit warnings is unlikely to dip too low while there is still so much uncertainty in the outlook and significant potential for misreads.”

Retail on the ropes

FTSE General Retailers issued 8 profit warnings in Q1 2016, compared with 7 issued in the previous quarter and 6 in the same period of 2014. This is the biggest first quarter peak in warnings since 2011 and takes the total number of warnings issued during the vital fourth and first quarter to 15, with one fifth of the sector warning just in that time. 

Christian Mole, EY transaction advisory services executive director and retail specialist, says: “We’ve seen in recent years how rising operational costs and the hard bargain driven by the UK consumer have chipped away at the benefits of rising disposable income and demand. This year looks no different, with additional challenges and opportunities that will further differentiate between retail’s winners and losers.

“Retailers that emerge as the winners will be those who can significantly improve their productivity and remain relevant to customers. Much of what we have seen in recent years has taken the form of short-term responses to problems of space, price and technology that need long term solutions. Retailers will win market share by being bold with new propositions.  Being bold doesn’t mean expanding budgets; but it does mean acting fast, if necessary failing fast, making sure lessons are learnt for the next time – and to keep going.”

Healthcare sector not so healthy

Companies in the FTSE Healthcare Equipment & Services sector issued five profit warnings in Q1 2016, equal to the record total issued in the previous quarter. In the six months to the end of Q1 16, almost a quarter of the FTSE sector issued a profit warning. Recruitment and pricing problems continue to plague medical services companies, while most equipment companies warning hit contract issues.

The timing of this profit warning peak is unlikely to be coincidental. The Government’s long term plan for the NHS, known as the Five Year Forward View, aimed at efficiency savings and the Carter Review into operational productivity in acute hospitals will have an ongoing impact. But, the more immediate driver in this context is likely to be the application of control totals, with a number of Trusts potentially delaying expenditure – in particular non-critical capital expenditure – to meet their individual control targets. 

Gill Cooksley, Executive Director of health advisory services, said: “Half the profit warnings issued by the sector in the last six months have cited delayed or discontinued contracts. Most of these have been issued by companies in the medical equipment sub-sector with a turnover below £50m per annum. As we have seen in other sectors – especially in FTSE Support Services – smaller companies have an inherent vulnerability to disruptions to the contract cycle.

“Nevertheless, amidst the challenges, there are also significant opportunities for companies in the domestic market in the context of rising healthcare spending, a growing and aging population, the move to community based care rather than hospital based and limited capacity within the NHS. There will be push-back on contracts and we expect to see further pressure on pricing, but there are also opportunities for companies who can offer innovative and cost-effective solutions that offer better outcomes for patients.”

Volatile, Uncertain, Complex and Ambiguous (VUCA)

Concluding, Hudson says, “The concept of a VUCA world isn’t new, but it’s hard to think of a more apt description for the outlook in 2016.  The year began with volatility in spades, until central bank action and rising oil prices inspired a late quarter rally. But, these are clearly tough markets for companies to read and predict, with mixed signals and the potential for further sharp changes in sentiment, prices and demand. The ambiguous outlook gives potential for misreads and we’re unlikely to see a significant drop in the number of UK profit warnings, despite the drop in expectations and sustained growth.

“There is the potential for significant upside, if the clouds clear in 2016. The second half of the year could see a rush of action in new debt and equity issues and deals, if oil finds a sweet spot, inflation remains within acceptable bounds and geopolitical uncertainties lift to raise confidence.  ‘Be prepared’ seems be a good motto for the rest of 2016.”