Why are UK profit warnings still so high?

UK profit warnings have hit their highest second quarter level since the financial crisis. Our analysis shows more companies warning – and more companies warning more than once. Why is this happening? More to the point, how can companies avoid profit warnings when the future is so becoming more unpredictable?

The numbers

The bare profit warning numbers aren’t good reading for UK plc. According to our analysis, UK quoted companies issued 66 profit warnings in Q2 16. That’s fewer than the 76 issued last quarter, but up by 16% on the same quarter of last year. It is much more meaningful to assess profit warnings on a year-to-year basis given the obvious tie into the reporting cycle. The second quarter is normally quiet. It’s beyond the range of warning for the popular December year-end and poor Christmas trading. The March year-end warnings might slip in along with upcoming June concerns; but it’s a time when most companies are starting the year with new expectations and hopes for the financial year ahead.

 Nevertheless we recorded 66 warnings from 62 companies, 44% of whom – 27 companies – had already warned in the last 12 months.  This compares with 35% – 19 companies – in the same quarter of 2015.  So, it’s not just that more companies are warning. More companies are also warning more than once. Why is this happening?

The reasons

The obvious answer for the rise in the number of warnings in Q2 is the influence of BREXIT – before and after the vote. In Q2 16 we recorded seven warnings that cited BREXIT. The uncertainty and sterling weakness associated with the lead into and aftermath of the Referendum did make a difference. But without exception, companies who cited BREXIT also gave other reasons for their warning. Besides, BREXIT wasn’t an issue when 27 companies who warned in Q2 16 issued their first warning, so it cannot account for the rise in the number of serial warnings. Plus, we also saw the fall in the number of oil price related warnings.

But, the oil price is just one complication out of many. What we still have is a world where profitable growth is still relatively tough to come by – not least because it’s the environment is constantly shifting and changing.  And we can surely put BREXIT under this disruptive umbrella. Because what does BREXIT mean for companies if not the prospect of upheaval – without knowing exactly what that upheaval will be or how or when it will come.

 Within profit warnings there are increasing signs of the struggle to keep up in fast moving sectors, where some companies are on the right side of disruptive influences and others get left behind. This could be why there are more serial profit warnings. Once companies get on the wrong side, it’s really hard to get back –  especially if this requires a great deal of investment and it’s hard to raise prices to compensate. Retail is the obvious sector in the vanguard of technological and behavioural change and a third of sector warnings issued in 2016 have cited the need to invest more.

The disruption we see – in the broader sense of upheaval and change – isn’t just technological. Changing regulation and the ever changing geopolitical outlook is also creating a challenging environment. Profit warnings from travel companies were rising before BREXIT and those we’ve seen since have all mentioned the difficulties of operating in a world of greater geopolitical turmoil and fear. In the last year, two in five quoted travel companies have warned.

Of course change is normal, but it’s the pace of change and its unpredictability that we’d argue is the difference. BREXIT just adds a further complicating layer of uncertainty and “known unknowns” – with the added problem (bonus for some) of a weaker pound. But still, most warnings are for non-BREXIT reasons and most UK quoted companies – over 80% in the last year – haven’t warned.  So how can companies avoid being on the wrong side of expectation?

 The response

Arguably there are some profit warnings that are unavoidable. Some companies will always be caught out by a totally unexpected turn of events without an obvious contingency.  Most profit warnings don’t fit into this category. It is difficult to forecast in this environment, but companies can help themselves by becoming more resilient to the inevitable bumps in the road by being more agile and adaptable so they can move quickly when times change.

 In this ever changing world companies also need to look at developing agile, risked based forecasts. The benefit of improved forecasting is  significant, from better shareholder communications to more effective planning and decision-making. Obviously there is a great deal that is unknowable these days– which is why forecasts need to acknowledge and reflect the uncertainty in the underlying assumptions. These assumptions should be revisited regularly and stress-tested against a series of risk-based scenarios that consider the impact on financial performance, liquidity and solvency. Companies can then think about mitigating actions – tying in to our previous comments about post-BREXIT planning.

 What next?

Constant and rapid upheaval and transformation are now the norm – as it seems is a high level of profit warnings. The third quarter of 2015 brought a spike in companies missing expectations as the low oil price hit home and fears of imminent US rate rises contributed to a global shudder. There’s a certain sense of déjà vu this summer with regard to Fed speculation; but the global economy is stronger in places and we could see further stimulus for the UK economy.  This could calm fears if deal negotiations go well. The latest surveys and our figures show confidence is certainly fragile. In Q2 the FTSE Support Services sector – our canary in the coalmine due to its broad business exposure – issued the highest second quarter total of warnings since 2009.

Support Services PWSo what happens to the numbers could depend significantly on the official response. But what we’re certainly seeing is a shift in the profile of warnings. There is already a noticeable increase from the real estate sector and from companies exposed to sterling on the transactions side, reflecting the latest change in dynamics. How quickly companies and forecasts will adjust is another unknown.