Treacherous times ahead for UK plc as profit warnings remain high in Q2


Research released by Ernst & Young reveals that UK plc is experiencing treacherous conditions as profit warnings for the second quarter of 2008 hit 98; the highest second quarter figure since 2001 and up 11 per cent from Q2 2007.

There were however at least a further 15 companies who stopped short of issuing a full profit warning stating that they would need to lower expectations if conditions did not improve.

Despite a fall in the total number of profit warnings, more companies with turnover over £1bn warned in Q2 2008, double the number in Q2 2007. Half these larger companies blamed the credit crunch for their profit warning in quarter two compared with around one in five in the total population.

Keith McGregor, Restructuring partner at Ernst & Young comments: “After a pivotal quarter, it is clear that the ripples from the credit crunch have spread far beyond the financial sphere. Most of the 26 per cent of companies warning this quarter blaming the credit crunch for their woes came from outside the financial sector.

“Moreover, mistrust and trepidation has spread; raising capital is perilous and equity markets are demanding unprecedented reassurance, especially from the leveraged and those exposed to home construction or the consumer. These are uncertain and challenging times for UK plc.”

By percentage of sector warnings, the highest warning FTSE sectors in Q2 2008 were Household Goods & Home Construction (24 per cent), General Retailers (13 per cent), and Personal Goods (11 per cent).

House builders begin to feel the pain

As forecasted in our Q1 2008 report the Household Goods and Home Construction sector is suffering considerably. It issued the highest proportion of profit warnings by sector this quarter, driven by the troubled Home Construction sub-sector where almost 50 per cent of companies issued profit warnings in Q2 2008 and almost 75 per cent in the last six months.

The collapse in confidence of the UK housing market has added to the gloomy mood which has already set in. House prices are falling more than six per cent year-on-year and mortgage approvals, a key indicator of future prices and demand, are at record lows. Even more businesses rely on the retail activities that accompany a house purchase, sectors already demonstrating considerable distress this quarter.

Andrew Wollaston, Restructuring partner at Ernst & Young comments: “Market confidence in the sector has fallen to levels not seen before by even the most experienced operators. The spate of redundancies announced by house builders in the last week are clearly aimed at executing a strategy of mothballing their businesses and land banks until the market recovers. How long the recovery will take, is difficult to call. In the last property downturn of 1989, the average value of UK houses fell for six years to 1995 and then recovered to 1989 values in 1997.”

Consumers tighten their belts

The General Retail sector continues to feel the pinch this quarter as it issued 11 profit warnings. Despite declining in number since Q1 2008, it is still seasonally high and takes the total for the first six months of 2008 to 29, the highest recorded by the sector in the first half of any year.

Record numbers of profit warnings suggest the sector is under unprecedented pressure, and yet the official retail sales data showed the biggest percentage sales increase in May since records began in 1986. Whatever the explanation for the figures – and the Bank of England has previously expressed concern with the data – it looks like a temporary blip. There were few, if any retailers nodding in recognition at the official numbers.

Even if retail sales are holding overall, a high-level figure can hide sector specific weaknesses. Food sales were strong in June, although uplift was at least partly driven by general inflationary pressures across the grocery sector. Other sectors faired less well. Clothing sales showed their biggest decline since the survey began in 1984. Sales of durable household goods and furniture and carpets were also down, confirming company intelligence that a slowing housing market and faltering consumer confidence are having a seriously detrimental impact on ‘big ticket’ purchases.

Wollaston comments: “Retailers may continue to drive sales volumes throughout the summer using heavy discounting, but many retailers have already realised that the vanity of keeping top line like-for-like sales buoyant at all costs can have crippling effects on profits. Retailers will need more than good weather to compensate for consumer headwinds and their own rising costs and we expect the high level of profit warnings and business failures to continue.”

Torrid times to come

These are choppy waters for UK plc to navigate. A flood of profit warnings and alarming economic indicators are making equity markets increasingly suspicious and intolerant of errors, raising capital is fraught with dangers and credit has gone missing.

McGregor concludes: “Bad news is chipping away at confidence, but the extent of the eventual slowdown is still hard to predict. Perhaps we are at the end of the beginning, but only in a sense of now feeling the second round effects of the credit crisis on the housing and consumer markets, not in the sense of stable bank balance sheets. This still has a long way to play out. At best, flat line growth is a certainty, at worst, recession a real possibility. Businesses and consumers, many of which have not experienced either, will feel the harsh reality.”

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