UK GDP is back to pre-recession levels and the FTSE 100 is close to its highest level for 14 years.
Life should be rosy in corporate Britain after surviving a historic recession, so it seems incongruous that EY has found that UK profit warnings are at their highest level since 2011.
What’s more, the percentage of FTSE consumer goods firms issuing warnings over their performance has almost doubled, from 9% in the first half of 2013 to 16% over the same period this year.
A brief scan of this week’s results quickly identifies the culprit – UK-listed consumer goods firms are getting battered by currency headwinds.
Today British American Tobacco reported a 10% drop in first half headline revenues, despite revenues rising by 3% constant currency basis. Yesterday, soap-maker PZ Cussons said that its rise in full year operating profit was reduced by over 10 percentage pioints due to currency movements, while Unilever last week said currency fluctuations had a negative 8.5% impact on its first half results.
The negative impact of currency fluctuations has also been cited in the past two weeks by UK-listed SABMiller, Reckitt Benckiser, GlaxoSmithKline, Hilton Food Group and Compass Group.
EY found that over a fifth of profit warnings in the first half of 2014 were related to currency movement, compared with just 3% last year, adding: “The pounds rapid rise is one of the biggest pressures on earnings”.
The pound has risen by around 11% against the dollar in the past year, reaching its highest level for six years earlier this month.
The strengthening pound (which has also risen approximately 10% against the euro year-on-year) certainly appears to have had a dampening effect on UK exports generally. Non-EU exports fell year-on-year by almost 45% in May according to HMRC and have been on a steadily declining trend since summer last year.
But the major problem for multinational fmcg firms has not been a contraction in sales, but the hit when converting international revenues back into sterling for reporting purposes.
Sterling’s strength has been further exacerbated by currency weakness in a number of key emerging markets such as Brazil, South African and Russia. The devaluation of these currencies has particularly hit those fmcg firms that have exploited growing emerging markets demand in recent years as sales in Western Europe and North America weakened.
There are suggestions that fmcg companies have been slow to hedge currency movements, but such risk mitigation only eases the burden to a certain extent and can become prohibitively expensive given the vast basket of currencies the pound has strengthened against.
The currency trends eating into fmcg firms’ earnings may, though, be helping under-pressure retailers.
EY found that profit warnings from general retailers equalled the record first half low set in 2013 and 2002, but that the total percentage of retailers warning in the first half of 2014 is much smaller at 8%, against 16% in the same period of 2013.
With a far higher proportion of domestic sales than fmcg firms, retailers are not suffering from translating revenues into sterling to the same extent and many while benefiting from lower costs of imported goods.
The current strength of sterling is such that the International Monetary Fund warned this week that the pound was 5-10% overvalued and was preventing export growth.
The situation looks unlikely to improve in the short term. UK GDP growth and rising UK inflation has led to speculation about interest rate increases, which further strengthening picture for sterling. Indeed, Band of England governor Mark Carney recently said the strength of sterling could now limit the pace of interest rate rises.
EY concludes: “As forecasts adjust — and emerging market currencies stabilise — we expect currency-related warnings to slow. However, this headwind is unlikely to let up whilst the UK remains front-runner for the first interest rate rise.”