Friday Highlight  

How are supply chain issues disrupting profits?

Second, the UK stock market is heavily weighted towards resource sectors; the MSCI UK Index has an 11 per cent weighting in both energy and materials sectors (for the MSCI World Index, the weightings are 3 per cent in energy and 4 per cent in materials). 

That suggests the UK stock market received a profit boost from the recent surge in raw material prices and I suspect the support from that source will be more limited over the next 12 months. 

Finally, the confluence of Brexit and poor pandemic management implies the UK may be more susceptible to many of the supply chain problems mentioned above.

So, where will the profit squeeze be the most acute?

I suspect manufacturing sectors will be hit first (component shortages and/or rising energy prices) but that eventually most sectors will be impacted by rising energy prices, especially transportation and heavy industry, higher wages (mainly in traditional low-wage sectors such as agriculture, food manufacturing, hospitality, retail and logistics), and product shortages/lost sales, in the auto and retail sectors, for example. 

However, some industries have more pricing power than others, with those least able to pass on higher costs also being those with low profit margins. Unfortunately, it is those low-margin companies that suffer the biggest hit to profits when costs rise. 

Sectors that I would put into this category are retail, hospitality, auto, construction and transportation. 

Many of those sectors have had a torrid time during the pandemic and they will not be helped by the cost pressures coming from supply chain issues (any further Covid restrictions would add to the misery). 

Less impacted will be high-margin sectors such as technology, pharmaceuticals and service sectors such as financials, which will see relatively low impact from supply chain disruption. 

Some sectors such as semiconductor makers and oil and gas companies are actually benefiting from the current situation.

Lastly, governments around the world have shouldered a lot of new debt during the pandemic and fiscal rebalancing is likely to include a rise in corporate tax rates. 

In the UK there will be a 1.25 per cent increase in national insurance contributions from April 2022, which will apply further pressure to labour-intensive sectors such as hospitality. 

Further down the line, UK corporation tax is planned to be increased from the current 19 per cent to 25 per cent in April 2023. All else being equal, that would cause a 7.4 per cent decline in post-tax profits, but the impact is unlikely to be that big as tax allowances complicate matters.

In conclusion, the strong profit growth seen among UK quoted companies over the past year is unlikely to be repeated, with particular pressure likely to be seen in sectors such as retail, hospitality, transportation, auto and construction.