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  Quoted companies issued 72 profit warnings in Q1 2013 but numbers should fall if expectations remain in balance and the global economy holds steady – Ernst & Young report.

UK quoted companies issued 72 profit warnings in the first quarter of this year as the slow growth and global uncertainty that caused sharp jolts to profit expectations at the end of 2012, lingered into 2013.

According to Ernst & Young’s latest quarterly Profit Warnings report, UK quoted companies – Main Market and AIM listed – issued one less warning than the same quarter of 2012 and 14 fewer than the previous quarter, when 86 warnings were issued.

Although the number of companies issuing profit warnings fell slightly year-on year, the percentage of companies warning rose very slightly– from 4.9% in Q1 2012 to 5.0% in Q1 2013. This is due to the continuing fall in the number of UK quoted companies.

FTSE Support Services (13 warnings) and FTSE Software & Computer Services (11) companies issued the most warnings, with these sectors most vulnerable to cut backs from cancelled or delayed contracts and cash-strapped governments. Falling growth expectations at home and in growth markets continued to create issues for industrial companies, with profit warnings from FTSE Industrial Engineering (7) and FTSE General Industrial (4) companies rising year-on-year.

Slow growth still here but conditions improve

Keith McGregor, head of restructuring for Europe, Middle East and Africa, said, “The year started with the UK economy punch-drunk from last year’s rapid downgrade of global growth prospects. Uncertainties in the US, Eurozone and China hampered the UK’s weak recovery in the second half of 2012, with companies still feeling the effects in 2013 – not least because many concerns remained unresolved.

“But conditions for the year ahead look set to improve, as seen by the rise in GDP for the first quarter of this year. The concerted actions of central banks, improving business confidence and rising consumer spending could provide the UK economy with greater resilience in 2013.”

Packaging sector struggles

Companies in the FTSE General Industrials sector issued four profit warnings in Q1 2013, the highest quarterly number since the final quarter of 2007. All of the General Industrial profit warnings in 2013 have come from the containers and packaging subsector, where almost half of companies have warned in the year-to-date.

Alan Hudson, head of Ernst & Young’s restructuring team in the UK, commented, “Packaging manufacturers sit in a vulnerable position in the supply chain, stuck between powerful suppliers and customers with strong resistance to price rises. Raw materials frequently comprise more than half of the total cost base of a packaging manufacturer, making it vital to pass through price rises as completely and swiftly as possible. A tough proposition in any market, especially when customers stand firm and demand is falling.”

Mining takes a hit

Mining companies issued six profit warnings in Q1 2013, relatively low as a proportion of the sector, but this is the highest quarterly number the Profit Warnings report has recorded.

Until recently, miners appeared to have weathered the global economic storm, with high prices and strong demand from emerging markets providing a welcome buffer. However, weak prices, along with labour unrest and rising costs put pressure on earnings, whilst miners continued to invest large amounts of capital. Rates of return fell, operating and free cash flow deteriorated, and balance sheets started to look overleveraged.

These pressures have also made miners more vulnerable to profit warnings from price fluctuations and operational issues like strikes and supply disruptions.

Sectors preparing for recovery

The report reveals that some parts of the economy do look set for recovery. House builders have not issued a profit warning since late 2009. A rising market, a wider mortgage market and the government’s new housing scheme should provide a significant boost for the housing market and home construction in particular.

The retail sector is still heavily polarised with weak companies struggling against structural changes and low sales. Despite obvious distress shown by some retailers, Christmas met most expectations with just five General Retailers warning in Q1 2013, the same as Q1 2012. The tough environment of the last few years has also created leaner operators that should benefit from any improvement in consumer spending.

Hudson adds, “Of course, there are exceptions in any sector and one off incidents and structural changes will continue to catch out companies. For all companies, the ability to be innovative, flexible and quickly adjust operational structures to volatile levels of demand and changing customer behaviour will be a vital component of success in these difficult markets.”

Improving conditions but marginal recovery

McGregor concludes, “Although UK companies are issuing profit warnings at the same rate as 2012 there are good reasons to believe that this year will pan out more positively than the last – business confidence is returning and consumer spending should keep UK GDP in positive territory for the remainder of 2013. While this still only adds up to a marginal recovery, with growth well below par, profit warnings should fall, if expectations remain in balance and the global economy avoids a repeat of recent setbacks.”

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