Half empty, or half full?

This week’s blog comes from EY’s UK&I Markets Leader, Lee Downham.

Capital markets started 2020 with renewed optimism, but recent events have reminded us that new certainties and opportunities mix with old concerns and new worries. It’s this complex mix of forces that I think will create significant contrasts in fortunes – both between and within sectors – in 2020.

It’s a highly diverse picture, with implications for companies’ ability to access the capital they need to invest to create an innovative and purpose driven organisation – as we explore in this week’s blog.

Seeking 20-20 vision

The UK’s economic outlook has brightened. EY ITEM Club have raised their 2020 growth forecast from 1 to 1.2%, in response to their expectation of higher business and government investment. Global market began to rally in 2019 on the thawing of US-China relations

But, this increased optimism isn’t unqualified.

Many of 2019’s challenges persist and new ones are emerging. Brexit remains a significant unknown. Disruptive forces continue to create, but also challenge business models, with new technologies generating increasing cross-sector convegence – and competition. The coronavirus threatens the economic uptick – in the first half at least.

It’s through these conflicting forces that I want to explore the divergence of sector and corporate fortunes. Starting with the most powerful force of all in the UK economy…

The hesitant consumer

UK disposable income is forecast to rise by 1.8% in 2020. But consumers remain cautious and EY ITEM Club’s forecast for consumer spending growth is just 1.4%,from 1.2% in 2019. This leaves retailers facing intense competition, as we discussed in our recent webcast, within the rapidly evolving retail sector and across the the whole discretionary spending space.

Retail challenges

Source: EY retail webcast

FTSE Retailers profit warnings are higher in 2020 than the same point of 2019. This is partly a hangover from a tough end to last year; but there’s also on-going pressure from intense competition and constant structural change – which isn’t going away, as our retail webcast polling (above) underlines. The core message from the webcast: retailers need a real sense of purpose – and bravery – to reinvent themselves and thrive in this environment.

In a fast-changing world, retailers must have the ability to develop and execute new strategies at pace in response to constantly changing consumer tastes and the technological trends that drive different and new behaviours.

Brian Marshall, EY Partner, Head of Retail, Strategy and Operations, UK & Ireland

Consumer spending on experiences continues to show greater resilience than that on material goods.  The mood of last month’s EY Annual Hospitality & Leisure breakfast seminar was thus one of cautious optimism, albeit also tempered by an uncertain outlook and ongoing challenges – especially within casual dining, which remains under cost, but also structural pressure, from overcapacity and the increasing dining options offered by online takeaways.

hospitality strongest

Source:  EY Annual Hospitality & Leisure breakfast seminar

The seminar discussion also recognised a clear need for more companies to take the lead on innovation and sustainability. The sector is one of the UK’s biggest emitters of carbon. Which leaves it open to legislative risk, but also presents a significant opportunity if it can get on the front foot and show a real commitment to developing long-term value for the sector and society.

Companies that step forward and take a lead will find themselves in a brand-enhancing situation.”

Burger King CFO Tim Doubleday & Chairman of the Environment Leadership Team at Business in the Community

 

Global exposures

Hotelier optimism may be more fragile today. Overall, the budding global market optimism we saw emerge at the end of 2019 largely remains; but the mood is more volatile and tempered by the unpredictable impact of the coronavirus.

Recent travel restrictions have certainly created a short-term hit to growth. What we can’t predict is the long-term impact. A broader, more sustained outbreak would be devastating on a human and economic scale. A sustained suspension of travel, trade and production would seriously disrupt global supply chains and confidence.  We just don’t know what comes next – as recent equity, bond and commodity price volatility attests.

OPEC+ preparations for emergency production cuts indicate the level of oil & gas sector concern, with China being the secondhighest global purchaser of oil. Although this is one of several factors driving sector sentiment. Oil majors are also contending with the conflicting pressures to invest in their core businesses, create a sustainable future and satisfy shareholders. As EY’s recent Capital Confidence Barometer shows, up and downstream oil companies recognise the need to face price volatility and the sustainability challenge with agility, innovative approaches and an increasing focus on investment and M&A as they focus on their future purpose.

Infrastructure hopes

As previewed, infrastructure investment looks set to be one of the biggest forces for UK growth. The government has signalled their intention to invest, with a more stable political climate also releasing private sector spending.

Construction has been through a torrid few years – as our recent profit warning data highlighted –  and there will be some lag yet before shovels hit ground, with some existing public-sector projects – notably HS2 and smart motorways – under review. The other caveats to consider are the uncertainty around the extent and location of public sector investment; the capacity of clients and contractors to agree a mutually acceptable balance of risk-and reward; the ongoing cost and labour headwinds in the context of an uncertain Brexit climate.

The biggest opportunities out there will benefit those who can manage risk and harness innovation. Construction is a systemically low margin business and any company that can use technology to reduce costs by 1-2% would have a significant advantage.

Technology game changer

And it is investment in the UK’s technological infrastructure that is the biggest potential game changer in 2020 and beyond. The advent of 5G puts telecom and technology companies at the forefront of driving a huge opportunity for all industries. The move from 4G to 5G sounds incremental, but the massive leap forward it offers in speed, capacity and connectivity will fundamentally transform the role that mobile technology plays in society.

As such, 5G will revolutionise industrial and working environments, with impacts well beyond the telecoms sector. Many companies will benefit directly from the investment required and indirectly from the improvement in mobile connectivity. In fact, the disruptive impact on the telecoms industry is perhaps one of the most uncertain elements. Convergence, competition and collaboration will intensify in the 5G era, with increasing opportunities to disintermediate existing suppliers., as our latest report highlights.

This new era of intelligent connectivity offers the chance to recast customer value propositions, accelerate industrial transformation, and reinvigorate the digital society. However, a positive outlook for the European mobile industry is by no means certain.

Tom Loozen, EY Global Telecommunications Sector Leader

Capital takeways

What I take from this brief sector tour is two crucial, inter-linked trends.

The first is the amplification of cyclical pressures by disruptive forces that are changing the whole structure of sectors through convergence and the creation of whole business models. This is creating a divergence of fortunes both between and within sectors.

The second is companies’ increasing need for capital to invest in creating innovative, sustainable businesses with a clear purpose. There is a clear need in most sectors for companies to demonstrate purpose and value beyond core financial metrics.

The first factor has clear implications for the second. Access to capital has been relatively easy and cheap for almost a decade now, but I don’t think companies can take this for granted – especially if we see Brexit concerns ramp up again at the end of 2020.

There is a clear shift in the market towards private capital, given greater regulation in public markets. It is already becoming more difficult to raise new capital in domestically stressed sectors, like retail, where 60% of our webcast attendees expect a tougher capital environment in 2020.

But, even in fast-growing areas, there will be competition, with companies that can articulate the greatest value story winning out.

Retail purpose

Source: EY retail webcast

Indeed, companies without a strong long-term value story risk losing the trust of their broader stakeholder groups.

It’s telling how many large spin-off deals have been announced recently,  with companies clearly articulating the clear purpose of each differentiated part of the business – and how they intend to repurpose capital to invest into their long-term growth story.

Whatever sector you’re in, purposeful growth is the theme of 2020.

Edited by  Kirsten Tompkins