Profit Warnings Are Falling

Published in Investing on 10 October 2011

But some sectors still look sickly.

Profit warnings from listed companies dropped in the third quarter, according to the latest data from accountancy firm Ernst & Young.

Warnings wane

Between July and September, companies listed on the London Stock Exchange and the Alternative Investment Market (AIM) issued 51 profit warnings.

In the previous quarter, from April to June, listed firms issued 64 warnings, so things have improved somewhat since mid-2011. However, there were only 46 warnings in the third quarter of 2010, five below the latest figure.

The worst-hit sector was General Retailers, which issued six profit warnings in the third quarter. In a very worrying trend, UK retailers released more profit warnings in the first nine months of this year than in the whole of 2009 and 2010 combined.

Significantly, these recent profit warnings have come after analysts sharply downgraded their forecasts for corporate profitability. This suggests that economic improvements are not the root cause of the latest drop in warnings. Instead, low expectations seem to be behind the latest quarterly fall.

Ten sickly sectors

Alas, retailing isn't the only sickly sector in the UK right now. Media firms issued six profit warnings in the third quarter, followed by the Software and Computer Services sector with five.

In Construction & Materials, one in seven companies (15%) issued profit warnings in the third quarter, with five warnings in all. So far this year, one in four firms in this sector has raised a red flag over profits, making it the worst-hit sector for warnings in 2011.

Here are the London market's 10 worst-performing sectors so far in 2011:

SectorYTD %
Industrial Metals & Mining-50.2
Basic Materials-29.6
Leisure Goods-25.3
Financial Services-24.3
Oil Equipment & Services-20.1
Travel & Leisure-19.7
Automobiles & Parts-19.0
FTSE 100 index-10.1
FTSE 250 index-13.9

Interestingly, the worst-hit sectors so far in 2011 are not those with the greatest number of profit warnings. Instead, companies with the largest exposure to world growth -- notably miners -- have been hit hardest. Also, banks and other financial firms have taken a beating, thanks to fears over euro-zone debt defaults and a possible double-dip recession in the UK.

Ten slumping shares

Now for a quick look at the 10 worst-performing individual shares in the FTSE 350 index in 2011:

CompanyYTD %
Thomas Cook Group (LSE: TCG)-76.7
Premier Foods (LSE: PFD)-69.0
Mothercare (LSE: MTC)-68.7
Talvivaara Mining (LSE: TALV)-65.4
Cable & Wireless Worldwide (LSE: CW)-56.9
Essar Energy (LSE: ESSR)-53.6
Vedanta Resources (LSE: VED)-52.5
New World Resources (LSE: NWR)-51.6
Ocado Group (LSE: OCDO)-48.8
Pace (LSE: PIC)-48.6

Each of these shares has been smashed this year, plunging by between 49% and 77%.

Four are very sensitive to falls in base-metal and energy prices: Talvivaara, Essar, Vedanta and New World. Also, five are heavily exposed to consumer spending: Thomas Cook, Premier Foods, Mothercare, Ocado and Pace.

On several occasions, I've warned investors off these shares before their prices crashed, so I hope to have saved a few Fools from losing some of their wealth. Of these slumpers, I've repeatedly warned investors to avoid Essar and Ocado, both of which had floats that flopped.

Will Xmas tills ring?

Clearly, the really big test for British retailers will be how high-street spending holds up in the run-up to Christmas.

As I warned last month in Another Retailer Bites The Dust, many retailers pay their next quarterly store rents on Christmas Day. For those with disappointing sales, this big bill could be the straw that finally breaks the camel's back.

Indeed, Ernst & Young warned that UK retailers will suffer their 'biggest test' since late 2008, when Woolworths bit the dust. Retailers face hostile high streets, largely due to falling disposable incomes and high inflation leading to lower consumer spending. In the second quarter of this year, consumer spending fell by 0.8%, its biggest drop for two years.

Thus, only retailers who keep a tight rein on sales, margins and cash flow will weather this winter in good health. What's more, Ernst & Young cautioned that retail insolvencies usually peak in January, but that several retailers might run short of cash and fail before this year is out!

More from Cliff D'Arcy:

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