Keith McGregor, restructuring partner at Ernst & Young says: "A stronger than expected start to the recovery has provided many UK companies with the opportunity to leverage efficiency savings and exceed earnings expectations in the last twelve months.
"However, there are already signs that 2011 could be more testing for some parts of the UK economy. Market conditions in several service sectors are already tightening, even though the full impact of the Chancellor's austerity measures have yet to arrive in earnest. Substantial changes to levels and patterns of public sector spending, both here and abroad, make some long-term losers and short-term pain inevitable"
McGregor cautions that it will take some time for companies serving the public sector to work through what the changing landscape means for them, with contract cancellations and a spending hiatus likely to produce more profit warnings this year."
Focus on sectors
Retail
Profit warnings from the FTSE General Retailers sector remained subdued in 2009 and for most of 2010, with 12 and 16 warnings respectively. However, by the final quarter of 2010, consumer confidence and spending power had begun to wane and retail profit warnings began to rise. There were six profit warnings from General Retailers in the final quarter of 2010, compared to the extraordinary fourth quarter of 2009, when no retailers warned at all. In addition, there have been a further six profit warnings from General Retailers in the first few weeks of 2011, compared with five for the whole of the first quarter of last year.
Alan Hudson, restructuring partner comments: "The snow features in all of the profit warnings issued in this first quarter by General Retailers and appears in many of those issued at the end of 2010. Unquestionably, the extreme weather in December had a negative effect on trading and compounded the pressures on retailers.
However, the strong differentiation between winners and losers this Christmas suggests that the snow, for the most part, simply exacerbated and amplified existing internal problems and structural trends in an increasingly tough and competitive market.
"Christmas was a taste of tougher times to come. Many of the positive influences on consumer spending that kept retail sales growing and profit warnings low during the recession and early stages of recovery had already begun to reverse by the final months of 2010. Rising material and labour prices and the squeeze on consumer spending power look set to make 2011 a much tougher year for the consumer and the retailer."
Construction & Materials
The FTSE Construction & Materials sector issued ten profit warnings in 2010, compared with just four in 2009, bucking the overall trend of year-on-year decline. The sector is under less immediate pressure than at the height of the credit crunch in 2008, but three tough years are taking their toll with the construction industry featuring highest in 2010 insolvency data.
Hudson says: "Given the likelihood of a patchy recovery in the private sector and restrained spending in the public sector, opportunities for construction sector growth will be limited in 2011.
"Construction companies have already done a great deal to manage their costs, but they will need to focus on their cash flow management and ensure they are mitigating the risks around unexpected delays and cancellations. Competition will intensify and contracts will be exceptionally price sensitive."
Outlook for 2011
The momentum gathered by the recovery so far means that the UK is unlikely to enter a second economic dip in 2011. However, GDP growth could slow at the start of this year and a short period of mildly negative growth is possible, especially if problems in the eurozone spill over into credit markets.
Keith concludes: "Forecasting will be more difficult and many companies have been rightly cautious in their recent statements. However, volatility in demand and prices in 2011 could still catch companies out and we expect profit warnings to rise back towards their average levels in the year ahead."
