Interactive Investor

UK profit warning trend mirrors 2008-9 global financial crisis

25th July 2023 13:40

by Graeme Evans from interactive investor

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The number of companies issuing profit warnings has risen again, marking the longest run of consecutive increases since 2008. Our City writer explains what’s going on.

Lots of red flags 600

Mid-market companies worth up to £1 billion are increasingly feeling the strain after they accounted for 29% of the 66 profit warnings in the April to June quarter.

That compares with an average of 19% over the previous three quarters as stress spreads across the economy and the reality of higher-for-longer interest rates hits home.

The downgrades contributed to the FTSE All-Share index ending the second quarter 1.5% lower, with the FTSE 250 down by 2.7% after warnings by building supplies firm Travis Perkins (LSE:TPK), bootmaker Dr. Martens (LSE:DOCS) and speciality chemicals firm Victrex (LSE:VCT).

Overall, EY said the number of profit warnings increased year-on-year for the seventh quarter in a row — the longest run of consecutive increases since 2008. Over the last 12 months, almost 18% of UK-listed companies have now issued a profit warning in a trend that also mirrors the 2008-9 global financial crisis.

The analysis by EY finds that the pace of warnings slowed in June but it warned that this could  “just be the end of the beginning of this cycle” as earnings downgrades are followed by a significant increase in restructuring activity.

The typical hit to shares on the day of an alert was 15.5%, but a meaningful change in the profile of the warnings meant this was lower than 19.9% in the first quarter.

At the start of the year, contract delays and cancellations dominated profit warnings as businesses rethought spending plans. However, the deterioration in credit conditions lay behind one in five profit warnings in the second quarter.

The report said: “Companies are feeling the impact on their own balance sheets, on their customers, and on demand in the wider economy, especially in sectors where credit availability has been a key driver of activity.”

This was most obvious in the housing market, where a slowdown triggered 14% of profit warnings in the second quarter and the highest level of construction warnings in three years.

The sector with the most warnings in the quarter was industrial support services on seven, with the six for construction and materials ahead of retailers and pharmaceuticals and biotechnology after both recorded five warnings.

FTSE chemicals also had its worst first half level of profit warnings for over 20 years, with almost half the sector sounding the alarm in the last 12 months. This came as macroeconomic uncertainty triggered widespread destocking and made it harder for companies to pass on the impact of a big shift in energy and cost prices.

One of those companies was FTSE 100-listed Croda International (LSE:CRDA), which said in June that profit margins had stayed the same as the second half of 2022.

Shares fell as far as 5,274p but the City’s rebased expectations have provided an attractive entry point for investors to gain exposure to a century-old company whose products span pharmaceuticals, sun protection and seed enhancement.

Today’s half-year results showed profits fell by 39.6% to £174.3 million but the East Yorkshire-based company left its guidance unchanged and underlined its confidence by maintaining the interim dividend due for payment on 3 October at 47p a share.

The shares rallied 226p to 5,888p but with analysts at Jefferies backing the stock to recover to 7,000p and UBS looking for 6,700p.

However, the recent report by EY notes that more companies are falling into a downward spiral of multiple profit warnings.

In the second quarter, EY said 29% of companies warning were doing so for at least the third time in 12 months, up from 10% in the previous quarter. Of those 36 companies on their third warning in 12 months, EY pointed out that 22% have already delisted — mostly through administration or distress sales.

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