Profit warnings

EY has been analysing profit warnings from UK companies since 1999. In that time, there have plenty of market shocks that have caused firms to miss their targets: the dot com crash, the global financial crisis, and, more recently, the Brexit vote. And yet EY believes that the signs from this years’ Q2 earnings season are particularly ominous.

While the number of warnings is at its lowest since 2010 – just 45 listed companies issued profits warnings in Q2 2017 – EY believes that “things will get tougher from here” and they conclude that the next 12 months look “tricky to navigate”.

Perhaps most tellingly, the market has been punishing profit warnings far more than in recent years. The average share price fall following a warning was over 16% in Q2 this year, compared to an average of 10% over the previous seven years.

A number of factors are at play here. 

First, Brexit. British boardrooms are caught between government inaction on Brexit and market demands for forward planning. The fact is that it is impossible to plan when the outcome is unknown.

Second, consumer confidence is looking distinctly fragile. EY points out that the sector delivering the most warnings was General Retailers. This carries warnings of pressure on consumer confidence, and misplaced earnings expectations. In short, companies have not kept the market abreast of the latest signs from the high street and their own web traffic.

Third, it is no secret that markets are on a long bull run. The FTSE 100 has (at last) exceeded the level it reached in 2000. The Dow sets new records with regularity. The Eurozone is back in favour. All of which makes any unexpected profit warning even more shocking. Hence the steeper than usual share price declines.

What can we learn in the GCC from this trend? Should regional IR teams be preparing for profit warnings?

While the EY study was all about the UK, and the contributing circumstances are very UK-specific, there are lessons to be learned in how to prepare for disappointing numbers; and Heads of IR here in the GCC can take steps now to soften the market response if they find themselves in the same position.

The first thing to acknowledge is that warnings often come as a shock to insiders, as well as to investors. The sophisticated IRO will regularly question the numbers coming out of the finance department, asking: Are you sure? Do your budget plans match our market guidance? Is the guidance still realistic? Establishing this robust relationship with Finance means that, if a warning has to be issued, the IRO will be aware in good time, and can prepare accordingly.

In the event of a warning, analysts and investors will always want more information and detail, so any temptation to keep the bad news short and sweet should be resisted. And companies must make sure that when the statement comes out, they are focusing not just on the bad news, but also on what they’re doing about it. It helps if there is plenty of forward commentary to go with a profit warning. 

Access to management is another consideration. Financial journalists, analysts and investors often want to see management face to face so they can pick up on body language. Sometimes a webcast or conference call with a Q&A session is sufficient – certainly, it will be more effective than a terse press release with no follow-up. Anything the IRO can do to provide information and background will repay the effort.

Failure to answer questions on profit warnings can further depress the stock price. While no CEO or CFO wants to face a crowd of unsettled analysts and investors, it’s best to deal with their queries in an upfront manner. The IRO can prepare and rehearse them for just such an eventuality. 

But the ideal way to handle a profit warning is not to wait for the bad news to hit before establishing clear, consistent communications with analysts and investors. Good investor relations are established by regular news flow in good times and bad. This is where the IR and Communications teams should be working together to ensure a steady flow of news, building relationships and contacts, and establishing themselves as reliable and credible points of contact. 

Follow these principles, and IROs can lessen the chances of a profit warning turning into a share price shock.