By Daniel Hunter

UK quoted companies issued the most profit warnings since the height of the financial crisis last year, as mounting risks across the Eurozone and US, combined with a slowdown of growth in China, knocked business confidence and reduced demand, encouraging a climate of inertia.

According to Ernst & Young’s latest quarterly Profit Warnings report, UK quoted companies - Main Market and AIM listed — issued 86 profit warnings in Q4 2012, 26% more than the previous quarter, taking the 2012 total to 287 — the highest since 2008.

In total, over 15% of UK quoted companies issued profit warnings in 2012, the highest annual proportion of companies warning since 2008, when nearly 18% warned. Concern over the economic outlook for 2013 peaked in the final quarter of last year, when 26 companies cited delayed or cancelled contracts in their profit warning — higher than the previous peak in 2008.

Business service companies issued the highest number of warnings in Q4 and 2012 as a whole, hit by falling activity, widespread corporate cost cutting and contract delays. FTSE Support Services issued 15 profit warnings in Q4 2012, taking their annual total to 46 and FTSE Software & Computer Services issued eight warnings in the final quarter and 24 warnings in 2012.

Keith McGregor, head of restructuring for Europe, Middle East and Africa, said, “Profit expectations dropped sharply in 2012 as economic forecasts fell and escalating risks in key global economies unnerved businesses, leading to delayed investment and purchasing decisions. The UK economy lacked the strength to gather momentum against this difficult global backdrop and finished 2012 with nothing more than a low growth landscape on the horizon.”

Industrial companies saw the largest increase in the number of profit warnings in 2012, with customers reacting to a volatile economic landscape by delaying orders and destocking. The FTSE Electronic & Electrical Components and FTSE Industrial Engineering sectors both issued 17 warnings in 2012, up from five and eight respectively in 2011.

The transport sector also suffered from falling expectations. Almost 40% of FTSE Industrial Transportation companies issued a profit warning in 2012, compared with 16% in 2011.

Alan Hudson, head of Ernst & Young’s restructuring team in the UK, says, “Falling economic expectations and rising uncertainty that characterised 2012 led to falling demand across industrial sectors, especially in the final quarter of last year. Slower than expected demand from China in particular landed heavy blows on companies reliant on emerging market growth, which would have cancelled out declining sales elsewhere.”

Unusually, the overall rise in profit warnings was not accompanied by a rise in warnings from consumer-facing sectors, including retail. FTSE Travel & Leisure companies issued just 11 profit warnings in 2012, down from 14 in 2011. Warnings from the FTSE General Retailer sector fell to just 17 in 2012, from 39 in 2012 — the lowest number since 2002.

But as Hudson explains, this doesn’t necessarily mean that the consumer service sector is under considerably less stress. “Profit warnings are a matter of performance against expectations and a squeeze on consumer spending was factored into retailers’ 2012 forecasts. The number of warnings in these sectors stayed low because the consumer squeeze was just about in line with expectations and the summer celebrations added a welcome boost to trading that the weather couldn’t entirely dent.”

Retail sales, while within forecasts, were still essentially flat this Christmas and there is an obvious discrepancy between low numbers of profit warnings and the retail administrations that have occurred at the start of this year.

Hudson adds, “The inconsistency highlights the extreme polarisation of consumer sectors exposed to the greatest technological changes and transformation in consumer behaviour. Those who have adapted best and those who continue to offer the best products, value and service have emerged as strong winners. In a flat market, this inevitably creates significant losers.”

Barring further economic shocks, the number of UK profit warnings is likely to fall in 2013. Profit expectations took a considerable hit at the end of 2012 as companies adjusted to lower levels of demand. Further dramatic adjustments are unlikely unless 2013 brings a further escalation of risk in key economies.

McGregor concludes, “Eleventh-hour deals in the US and the Eurozone have removed the immediate threat to global markets, raising hopes of a more stable year in which a recovery can plant stronger roots.

“But even if the year ahead proves uneventful, it is still set to be a testing time for UK Plc, with tough competition for modest growth and seismic changes occurring in many industries. Technology and patterns of demand are changing faster than some companies can adapt — especially mature companies with weighty pension, debt and real estate legacies. The ability to be flexible and quickly adjust operational structures to volatile levels of demand and changing customer behaviour will be a vital component of success.”

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