Profit warnings from UK-listed companies have now increased for the seventh quarter in a row, according to the latest report from EY-Parthenon, with firms issuing 66 warnings during Q2 2023 alone.
This marks the longest run of increases since the global financial crisis in 2008-9, and is the highest number of warnings for a Q2 period since the start of the Covid pandemic in 2020.
Some 20% of these firms cited tighter credit conditions as the key reason for ailing profits which, according to EY, is the highest proportion since Q2 2008.
A further 14% of profit warnings were attributed to the slowdown in the UK housing market, including both sales and demand for housebuilders.
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Indeed, six of the 66 profit warnings alone came from FTSE-listed construction companies, with 28% of firms issuing at least one warning in the last 12 months. This means warnings from the construction sector have reached their highest level in three years.
Jo Robinson, Head of UK & Ireland Turnaround and Restructuring Strategy at EY-Parthenon, explained that contract delays and cancellations were the key driver behind profit warnings as cost pressures first began to rise, and that contract-cutting and cost-saving continued into Q2 2023.
Now, however, she said rising interest rates is “undoubtedly the biggest story of the quarter”.
“The number of businesses and consumers that had previously locked in low interest rates has postponed the impact of rising base rates, but not indefinitely,” Robinson warned.
“While we may have reached the peak of the earnings downgrades, we know from over 20 years of profit warning history that this is when insolvencies and restructurings start to increase too.
“We are already starting to see increasing divergence between bruised companies, that are struggling to build the operational and balance sheet strength to recover, and those that have reshaped and are re-energized to make the most of growth and opportunity.”
She added that “a tighter capital environment will only amplify this divergence”.
“We might be at the peak of the earnings downgrade cycle, but we are just at the beginning of the challenge for many companies.”
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Indeed, almost a third (29%) of companies with annual turnovers of between £200m and £1bn issued warnings, which marks the highest proportion of profit warnings from mid-sized companies in four years. While the all-encompassing FTSE All-Share index fell by 1.5% during Q2 this year, the FTSE 250 lost 2.7%, while the FTSE Aim All-Share index saw almost 7% of its value wiped.
“[This] underlines the fragility of investor confidence and the increasing difficulty smaller companies face when trying to raise funds in this tighter capital environment,” Robinson said.
“Investor reaction to profit warnings in the second quarter looks more muted, despite this fall in confidence.
“On average, the share price reaction to profit warnings tends to be higher for smaller and AIM-listed companies and lower for larger and main market companies.”
Sectors
Industrial support services suffered the highest number of profit warnings at seven, followed by construction & materials at six, and both retailers – and pharmaceuticals & biotechnology – at five each.
Industrial FTSE sectors increased by 40% overall on a year-on-year basis, as the negative impact cost-cutting within tech sectors during Q1 spread to industrial sectors the following quarter.
Robinson said: “There are other signs in our data that increased stress is passing through supply chains. Weak demand caused FTSE chemicals companies to hit their highest first half level of profit warnings for over 20 years, with almost half the sector warning in the last 12 months.
“Biotechnology companies also issued their highest first half total of profit warnings in over 20 years. The three top reasons for warning in Q2 2023 were falling sales (59%), contract issues (23%), increasing costs and overheads (23%), which reflects this uncertain demand as well as easing, but still elevated, overhead costs.”
