Five themes for autumn & beyond

In the past few weeks we’ve published a number of reports that help to build a picture of the health, hopes and expectations of UK plc. It’s not pixel perfect, but it feels like a good time to take stock and pick out a handful of themes that we think will endure through autumn and beyond.  UK plc is doing ok – better than expected in fact– but current performance is no guarantee of future results. As we found out today – we can take nothing for granted!

Always something….

The World Trade Organisation former director general Pascal Lamy recently said that Brexit will be like “taking eggs out of an omelette”.  We could use the same analogy with regard to trying to separate Brexit from the rest of the world’s unknowns – known or otherwise.  It is a complex world of intersecting opportunity, risk and uncertainty as our Quarterly Profit Warning paper for Q3 2016 highlights. Out of 68 profit warnings, 20 – just under a third – mentioned Brexit. But it’s never mentioned alone and of course this means that over 70% of companies are missing their forecasts for other reasons – the same competitive, disruptive pressures and internal failures they had before anyone put ‘Br’ and ‘exit’ together.

And what does ‘Brexit’ mean now anyway after today’s high court decision, which says Parliament should vote on Article 50? The fact is that there is always something unexpected happening – from geopolitics and to the skies.  Just thinking back to last summer, it was the oil price and worries about China and the Fed that drove profit warnings to a post-crisis high for a third quarter.  Before that the pound was too strong and the weather is never quite right….

Companies might not have a perfect understanding of their risks and opportunities, but they can still take a systematic approach to thinking about where they challenges might come in key areas, how these might intersect with their business and how they might flex their operational and capital models to cope.

 

2.       Mixed and delayed impacts

It’s interesting to note that profit warnings relating to the falling oil price were still going strong in the second half of 2015 – a year after the oil price began to fall.  In this 24-hour news culture there’s often an expectation that effects will be simple and dramatically immediate, when they can often play out through secondary causes and down supply chains through many months.

In the case of sterling, currency hedges have delayed any immediate hit to producers and the reluctance to pass price rises has delayed the impact on customers. But,  if the pound doesn’t recover ground – the pressure has to burst somewhere and inflation will rise, hitting earnings and consumer spending. Q3 GDP held up – but showed the UK still largely flying on the now vulnerable consumer engine.

UK executives were betting on a sterling revival over the summer, when we conducted our Capital Confidence Barometer (CCB15) – there’s still uncertainty, but the pound has only moved up slightly on today’s Bank of England growth and inflation upgrade – and the high court ruling. Like the oil price fall, the impact of sterling’s movements is also mixed. Our profit warning data shows that a weak pound has tended to trigger fewer warnings than a stronger one – although we’re not sure we can draw strong parallels given the different global backdrops. What we can say is that recent PMI surveys, whilst positive, have been full of news of rising prices. And in today’s ultra-competitive markets, that sounds like a problem.

There are clearly great opportunities and risks if the pound stays low and hedges run out. It is a “known unknown” for which companies can prepare – but it’ll be a tougher fix next time around.

3.       Watching the margin

It’s notable that during a period when official figures show retail sales rising by 5.4%, UK retail profit warnings hit their highest third quarter total since the financial crisis. Some things never change and that old adage about the sanity of profits holds true.

In retail, the pressure on margins was already relentless from the need to invest and keep prices low in competitive markets disrupted by online rivals with models that don’t include bricks and mortar.  That said, online retailer aren’t immune from problems, given their own need to invest heavily to establish their position. Moreover, the whole sector looks set to feel the margin vice tighten if sterling remains weak, pushing up the price of goods and hitting consumer’s wallets.   Support Services is another sector under margin pressure – and subject to the vagaries of economic uncertainty. Contract issues – slips, delays and cancellations – are a perpetual problem for the sector – as customers demand more from contracts.  Earnings forecasts for the FTSE350 have risen on the back of hopes for rising exports and overseas sales – but they’re dipping for the more domestic oriented small-caps.

We wonder if these pressures- Brexit-oriented and otherwise – might be the catalyst UK companies need to push on with innovation to improve productivity and margins. 

4.       Technology as frenemy

As we discussed last week, our CCB15 report shows that digital technology and innovation is at the top of the boardroom and M&A agenda.  Companies clearly recognise both the need and the opportunity to embrace new developments.  New car adverts seem to focus as much on their ability to communicate with your phone as their capacity for driving you from A to B.

But transitions can be tricky. A quarter of profit warnings from quoted retailers in 2016 cite unexpectedly high levels of investment. Bricks and mortar retailers are under pressure to keep both their online and physical storefronts attractive. Online shops loose supermarkets money.  Our CCB15 survey shows just 35% of UK respondents are duplicating automated and manual process  and, whilst 19% of UK respondents reporting that automation improved productivity, 43% said that prior investment in automation hasn’t been successful.

There’s no getting way from the increasing role of technology – but its positive impact on a business is not a given. Companies can’t ignore the march of progress, but they also need to keep an eye on costs and learn from mistakes – theirs and others.

5.       Mature UK economy WLTM investors for fun deals….
As recent events have illustrated, there are many issues rising for foreign companies with international customers and supply chains ostensibly from Brexit – and our CCB15 survey shows the UK dropping out of the top five global M&A destinations, which doesn’t bode well for investment. This concern does vary significantly by geography. A balance of 72% of Japanese investors and 16% of US investors said Brexit negatively affected their intention to invest in the UK, but Indian investors were overwhelmingly positive and Europeans moderately so.  Perhaps it depends on how much companies are using the UK as a gateway into Europe?  If so, are there other ways to keep foreign companies onside? We also have to ask if Brexit is the be-all and end-all of this change of heart and if we should look in the round – including the UK’s technological and physical infrastructure.

There is plenty the UK can do to improve its attractiveness in these areas and it will be interesting to see what comes in the Autumn Statement on 23 November. A few days later, EY publishes its updated UK attractiveness survey when we’ll get an updated view.


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