Profit warnings surge – forecasting is difficult in a divergent world

Highest number of profit warnings for 6 years – what happened to “Silver linings turning gold”?

A week is a long time in economics…

Profit warnings reached their highest fourth quarter total since 2008 in Q4 2014, with 93 warnings also taking the annual total for 2014 to a six-year high. But this news comes only a week after the EY ITEM Club forecast which set out a very positive prognosis for  UK growth. How can we explain these seemingly contradictory views of the economy?

       

This is a level of profit warnings more consistent with a period of low growth or global shock than an improving macro outlook. There were signs that the UK and global economies were slowing as 2014 came to an end but the level of profit warnings still appears out of line with underlying economic conditions. What this latest analysis shows us is how difficult it is to forecast in the current economic environment.

Graph for blog 1

…and it has been a long year for profit forecasts… 

The key features of profit warnings in 2014 set out below illustrate some of the key factors making forecasting so challenging :

  • More FTSE 100 companies warned in 2014 than at the height of the credit crunch, whilst total profit warnings from FTSE 350 companies were just three shy of the record 90 issued in 2008.
  • Adverse exchange rates, in particular a strong pound and weakening emerging market currencies, were especially troubling for the internationally exposed FTSE 350. In 2014, 17% of profit warnings cited exchange rates – including 27% of warnings from FTSE 350 companies.
  •  In 2014, 20% of warnings cited contract delays or cancellations, rising to 27% in Q4 2014. The FTSE sectors that are vulnerable to contract disruption led profit warnings in 2014, including Support Services (47), Software & Computer Services (28) and Media (16).
  • The pressure from the squeeze on real incomes is evident from the sharp rise in profit warnings from Consumer Goods companies in 2014 – up by over 70% from 2013. Pricing and competitive pressures triggered 21% of all profit warnings in 2013, compared with 7% in 2013.
  • Unsurprisingly, profit warnings in FTSE Oil & Gas segments rose from seven in 2013 to 11 in 2014. The rapid fall in oil – and other commodity prices – has compounded existing capex pressures, increasing stress for contractors and suppliers, with warnings coming thick and fast in 2015.

 …especially in a complex, volatile economic environment…

The economy has changed from the pre-crisis environment. No longer is strong growth helping all sectors to grow. What we see today is much more divergent performance but in a very interconnected world. As an example, the moves by the Swiss National Bank to stop its policy of intervention in the foreign exchange market were most likely driven by the expectation of capital flows increasing as the ECB moved to Quantitative Easing and Russian investors continued to respond to the fall in oil prices and the impact of sanctions.

The three most important drivers of profit warnings can be attributed to changes in economic conditions:

  • Exchange rates were a standout theme in 2014, peaking at 26% of warnings in Q1. The contrast between the strong pound and weaker Euro and emerging market currencies – together with weakness in these economies – help to push profit warnings from the internationally-exposed FTSE 100 to a record high. Healthcare, finance and support services sectors were particularly affected.
  • Competitive pressures were a constant throughout 2014. Low insolvency rates, new entrants and technological changes have brought seismic changes to previous market norms. The pressure to invest, and yet cut costs and prices, is transmitting strain along supply chains
  • Warnings citing delayed or discontinued contracts peaked in the final quarter as uncertainties upset contract cycles.  In the final quarter, 44% of warnings from the contract-dependent FTSE Support Services cited delays or cancellations.

Business must be prepared

There are clear advantages in these uncertain times for companies who can take the initiative and demonstrate resilience in the face of economic and market volatility. Companies will need to demonstrate clear vision and the ability to adapt their forecasting and planning capabilities to the dynamics of the post-crisis economy.

Many of these pressures represent new realities, rather than a passing phase. An improving macro outlook is no longer a guarantee of a smoother ride for UK plc. Undoubtedly, many companies have faced increasing challenges to their forecasts in recent months from rising geopolitical concerns and falling oil prices.

Forecasting and planning approaches must be adapted to allow for scenario analysis especially around key assumptions such as currencies and also for disruptive events. While it will not be possible to avoid shocks, careful up-front analysis will at least build an understanding and allow companies to have contingency operational and communication plans in place. This will provide the opportunity to mitigate adverse impacts on both results and market sentiment. This is the “new normal” approach to planning: many futures have to be considered; no longer can the past be used as the guide to the future.

 


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s