On the brink: profit warnings highest since the crisis

This week’s Capital Agenda Blog comes from Alan Hudson, Head of UK&I Restructuring.

On the brink of….a Brexit deal, a general election, a US-China trade agreement, a global recession? We know that uncertainty is a given in 2019. But, the persistent and deepening nature of this uncertainty took UK profit warnings to the brink of all-time high this summer  – and took more companies to the brink of survival.

In this week’s Capital Agenda Blog, we’ll use our latest profit warning analysis to explore which sectors are under greatest pressure and how companies can reshape their business to adapt to this world of uncertainty.

As bad as 2008?

There are three stark numbers in our profit warning data

235: the highest year-to-date total of profit warnings since 2008.

17.7%:  the highest percentage of companies warning in a 12-month period since Q4 2008

1 in 4: the proportion of companies issuing their third warning in the last 12 months that are no-longer listed

Clearly the economy isn’t as tough as 2008. Companies aren’t contending with a global recession and systemic financial risks. But, profit warnings aren’t an absolute measure of corporate performance. They track companies’ ability to make and meet their forecasts, which is clearly more difficult when trading environments could change overnight – a theme that does have echoes of the Global Financial Crisis.

EY Stress Index Q3 19.png

Our EY Profit Warning Stress Index, which measures the percentage of companies warning over a 12-month period, has only been higher once – in Q1 2009.  Even at the post-crisis peak of 100 warnings in Q4 2015, the index only hit 88 compared to 96 in Q3 2019. That’s because the pressure in 2019 has been more persistent and widespread than in 2015, when the pressure was chiefly focused on companies exposed to the sudden fall in oil prices.

In the last 12 months, EY has recorded profit warnings from 40 of the 42 FTSE sectors we track, compared to 37 in 2015.

Our Index can only hit this kind of level when global and domestic stresses trigger widespread sector downgrades persistently over a 12-month period. This isn’t just about Brexit – which triggered 22% of profit warnings – but the broader context of significant global downgrades to growth expectations and the wider picture of rapid technological and attitudinal change.

Such are the shifting sands of business,  the UK market for plastic straws all but disappeared overnight.

Eroding confidence

After such a significant period of downgrades, we often see earnings forecasts stabilise and profit warnings fall; but we also need to remember that there are a huge number of downside risks driving this uncertainty – most of which have yet to crystallise.

Moreover, whilst this is a less dramatic economic and banking environment than 2008, this is still a febrile environment in which to issue profit warnings. Median share price falls on the first-day of warning are at record levels. Our analysis of the last 20 years of profit warning data shows that one in five companies issuing three or more profit warnings* delists within a year of their final warning. One in ten falls into administration. Since 2016, the median time between third warning and a restructuring event has fallen below 90 days – or less than one quarter.

Double warners

To put this in a current context, seven of the 29 companies that have issued their third profit warning in the last 12 months have delisted due to administration, liquidation or sale so far in 2019.  There are a further 79 companies warning in the last 12 months for their second time with a clear imperative to act.

Discretionary exposure

Where is the pressure greatest? Profit warnings are coming from all corners of the economy, but the sectors exposed to the impact of uncertainty on discretionary spending and market volatility are issuing the most profit warnings.

Warning sectors 2019 to date

Consumer-discretionary sectors feature especially heavily and will be in focus throughout the final quarter. The issue isn’t with consumers’ ability to spend, but their willingness to do so and where that spend lands in a highly competitive trading environment. Even if uncertainty lifts to boost spending, many retailers will continue to struggle to capture consumers’ imagination as technology continue to reshape behaviour.

But, amid the focus on consumer sectors, we shouldn’t forget issues elsewhere across automotive, technology and other industrial sectors that signal a pull back in business discretionary spending.  The third quarter rise in warnings from media agencies and recent alerts from recruitment agencies are a strong signal of stress. So far in Q4 2019, most profit warnings have been issued within FTSE Industrials super-sector, many of which blame the difficult global macro-economic environment.

Fortune favours the decisive

Companies can’t build immunity to uncertainty, but they can build resilience by continuously strengthening and reshaping their business.

Businesses fall into a downward spiral for many reasons, from a failure to keep up with disruptive trends, to issues in contract delivery to accounting issues. But, whatever the reason, prevention is better than cure. Too often, companies take too long to realise that they have an issue and then fail to act radically and quickly enough to stabilise and turnaround their business.

A big part of the issue is the lack of accurate and up-to-date management information, which leaves businesses unable to identify a problem and act before they get into real difficulty.  But, there is little benefit spotting problems early if companies don’t engage decisively.

Making incremental cost cuts often leaves companies running to stand still. If they don’t release enough cash to invest in new areas, companies are just tinkering around the margins. Our Divestment Surveys consistently show companies acknowledging that they held onto non-core businesses for too long, when that capital could be reinvested into more profitable areas.

When faced with a fundamental change in their market, companies need to make equally fundamental changes to release the cash necessary to create the headroom and extra funds companies need to reshape their business. This is especially vital when companies are highly leveraged and have little room for manoeuvre.

None of these actions are that radical in and off themselves, but they need to be taken with a radical mindset.

Edited by Kirsten Tompkins

Our dedicated EY profit warning web site allows you to download our latest analysis and explore the Profit Warnings Console which provides you with access to over twelve years’ worth of  profit warning data at the click of a button.

Using the console, you can analyse warnings to identify the forces affecting your market to shape your path ahead.