The UK’s looming earnings “confession” season could pose a threat to investors, as the realisation dawns that companies are not bringing in enough profits to justify their heady valuations.
In recent years, many UK shares’ price-to-earnings (P/E) multiples have been increasing as sentiment towards the economy has improved amid a rampant bull market.
Shares on the FTSE 100 index of the biggest UK companies were valued at just 8.1 times the companies’ predicted 12-month earnings in September 2011.
Last week, that P/E multiple had reached 13.4 times, as investors were prepared to pay far more for the same companies, even though their earnings forecasts had barely risen.
But as UK companies report their profits in the coming weeks, disappointment could set in.
There are already signs of concern as the FTSE 100 hit a 12-month low last week when it fell to less than 6,350 points during trading on Friday (October 10).
At the end of September, both banknote maker De La Rue and infrastructure group Balfour Beatty warned investors on their profits, among others.
Adam Avigdori, co-manager of the £346m BlackRock UK Income fund, said October was normally “confession” season for companies who will not meet expectations for full-year earnings.
Mr Avigdori said while those UK businesses with lots of dollar earnings were benefiting from the recent strengthening of the dollar, “we expect this will be a subdued earnings season, particularly in light of the recent, weaker macro data in Europe and Asia”.
“This should be seen in the context of recently reduced expectations, especially in the industrial and materials sectors,” he added.
Chris White, manager of Premier Asset Management’s £395m UK Equity Income fund, agreed the start to the earnings season was a worry.
“One of the notable features of the past few weeks was the number of profit warnings that have already come out,” he said.
“The problem is they do not tie back into any one particular theme.”
Mr White added that the list of companies reporting negative results is getting ever longer. His fund has already taken a hit this reporting season.
He holds food group Tate & Lyle, which cut its profit outlook at the end of September and immediately saw its shares plummet, showing the market’s appetite to tolerate weak outlooks.
“It is too difficult to predict where the problems are coming from and where they are going to strike,” Mr White said.
Overall, companies are facing a tough macroeconomic background. While the International Monetary Fund (IMF) has delivered a glowing report on the UK’s economic prospects, with expansion of 3.2 per cent expected this year and 2.7 per cent next year, it noted the eurozone is struggling to recover.
The IMF said there was now a 40 per cent chance of the single-currency bloc suffering a triple-dip recession, double its April estimate.
This divergence will lead stresses and strains to appear in the global economy and economists expect increased volatility in markets.
Jamie Forbes-Wilson, manager of the £84.1m AXA Framlington Blue Chip Equity Income fund, said currency strength had been a particular headwind for companies.
“This year, dollar weakness and sterling strength have caused some problems,” he said.
“However, the dollar has gotten stronger and this could have a headwind effect. Still, I don’t think we will see the results of that until into 2015.”
Mr White did say he had found one sector that had weathered the storm with buoyant share prices in the past three months – banking.
He said this could be a turnaround period for the sector and while it was too soon to buy some of the banks for an income fund, because they do not pay dividends, growth managers should consider them.
Still, the general feeling in the market is not a positive one.
The next major reporting season will be February when many companies will release their yearly updates. With an increasingly challenging global macroeconomic background, these numbers are not expected to be great.
SHARE PRICES OF SOME UK COMPANIES ARE TUMBLING
De La Rue
British banknote printer De La Rue had its third profit warning in two years at the end of September.
The company cited overcapacity in the market as the main cause. It is facing tough competition in particular from state print works, such as Russia’s Gaznak.
De La Rue also cut its dividends. It expects to pay an interim dividend of 8.3p, down from 14.1p in the same period last year.
Its shares dived 33 per cent to 508p by the afternoon of the announcement.
They fell further in the following weeks and were trading at about 476p last week.
Balfour Beatty
Builder Balfour Beatty issued its fifth profit warning in two years.
At the same time, Balfour announced that chairman Steve Marshall, who has only headed the firm since May, will step down when a replacement is found.
The latest profit warning sent its shares tumbling 21 per cent to 177.5p.
The company was hit again after Blackpool International Airport, which it owns 95 per cent of, said it would close.
Markets were brutal in their response and shares plummeted further and were trading at about 150p on Friday.
Tate & Lyle
Food group Tate & Lyle cut its outlook for the half year. It expects first-half adjusted profit before tax to be between £95m and £105m, and between £230m and £245m for the full year. This is 22 per cent below consensus forecast, according to analysts at Citigroup.
The company cited an “extremely disappointing” performance because of price competition within the sweeteners market and supply chain problems.
The share price plunged 17 per cent to 610p by the afternoon of the announcement. It has fallen further and was trading at around 587p on Friday.
