Continued Credit Crunch: Implications for UK-Listed Companies and Profit Warnings

The EY-Parthenon report on profit warnings from UK-listed companies, released on October 30th, indicated a year-on-year decrease in profit warnings for the first time in two years. However, it emphasized that one-third of all profit warnings were linked to a credit crunch, its highest level since 2008.

If you’re wondering whether tighter credit conditions will persist and continue affecting UK businesses in the last quarter of 2023 and the upcoming year, it’s safe to say that as long as interest rates stay high to keep inflation around the 2% target, credit conditions will remain challenging.

But before exploring other key findings of this report that might help you fine-tune your investment strategy when it comes to UK-listed firms, let’s first understand what constitutes a profit warning.

What Is a Profit Warning?

As explained by EY, a profit warning occurs when a company formally informs investors and the public that its anticipated profits are likely to fall below earlier projections. This communication serves as a means for companies to caution stakeholders about potential financial difficulties or setbacks. While there are instances of positive profit warnings, where companies upgrade their growth forecasts because they anticipate better-than-expected performance, negative profit warnings are more frequent.

Some Key Figures and Data About UK Profit Warnings Issued in Q3 2023

• 76 profit warnings were issued (compared to 86 in Q3 2022 and 51 in Q3 2021).
• This represents a 12% decrease year-on-year.
• But it is still 18% above the Q3 average profit warning number.
• On the day of the profit warning issuance, the median share price fall was 15.1% (compared to 11.2% in Q2).
• 11 companies issued a profit warning for at least a third time over the last 12 months (compared to 18 in Q2).
• 40 companies are in the ’three-warning danger zone’ (compared to 36 in Q2 2023).
• 18% of the 40 companies that have issued a profit warning over the last 12 months have been or are being delisted.
• Sales short of forecasts, credit crunches, delayed or discontinued contracts, increasing costs and overheads, as well as operational issues are the most important reasons behind this quarter’s profit warnings.
• 20% of all profit warnings mentioned the weaker housing market.
• The construction sector continues to be exposed to the risks associated with tighter credit conditions and a decelerating housing market.
• Sectors reliant on discretionary business and consumer spending have faced challenges due to economic strains and fluctuating confidence.

Will Tighter Credit Conditions Drive More Profit Warnings in Q4 2023 and Beyond?

The decreased number of profit warnings in Q3 2023 can be attributed to the ease of cost and supply pressures, which is positive news. However, companies have faced significant challenges this quarter, primarily stemming from the impact of rising interest rates, leading to deteriorating credit conditions. In the previous quarter, the percentage of companies citing a credit crunch as the primary reason for their profit warnings (33%) marked the highest since the financial crisis of 2008.

In its monthly report, ING forecasts that the BoE official bank rate would be unchanged at 5.25% until at least Q3 2024 where it might go down to 4.75% before being lowered one more time in Q4 2023 at 4.25%. In addition to higher interest rates, the economic outlook isn’t really optimistic for the United Kingdom.

According to Barclays’ 2024 forecast, the economic prospects of the United Kingdom in 2024 is actually facing rather “stormy weather”… Julien Lafargue, Chief Market Strategist of Barclays declared that “with weak growth, elevated inflation and bulging government debt, economic prospects for the next twelve months seem tough enough. Add in a probable general election and investors should strap in for a roller-coaster ride”.

Can You Trade Profit Warnings?

Certain active traders engage in exploiting the increased market volatility that accompanies the release of key events or economic statistics, commonly known as news trading. When a profit warning is issued, investors frequently face a decision – some opt to sell their stocks, while others seize the opportunity to buy at a potentially reduced price, thereby contributing to heightened market volatility.

Financial instruments such as Contracts for Difference (CFDs), like those offered by regulated brokers like ActivTrades, enable traders to capitalize on both bullish and bearish price movements. For instance, traders can profit from a declining market by taking short positions through CFDs. While these products are a good way to profit from all market conditions over the short-term, they are also very risky. Trading during the earning season and when a profit warning is issued is also a very risky technique, as market reactions can be unpredictable and volatility is high. Therefore, you should always implement risk management tools, such as stop-loss orders for instance.

On the other hand, some investors take a long-term approach and perceive profit warnings as potential opportunities for investment. Viewing the profit warning as a temporary setback, they believe in the company’s ability to overcome challenges and recover in the future. In such cases, investors may choose to purchase the stock at a discounted price, particularly since profit warnings are often followed by a substantial price decline.

To make informed decisions in this context, however, investors need to conduct in-depth research into the company’s financial health and gain a comprehensive understanding of the factors leading to the profit warning to determine whether the company has the potential to bounce back from its current situation.

Disclaimer

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