UK plc extends longest period of profit growth since financial crisis.
The latest ProfitWatch UK analyses the results of the UK's top 350 companies reporting between April to June 2018. Best Financial Campaign winner at the PRCA Awards.
UK plc profits jumped 86% to £210.8bn in the year to the end of June, extending the longest period of growth since the recovery following the financial crisis. The increase was exaggerated by a very large profit British American Tobacco made acquiring Reynolds American. However, even without that, profits rose 66%. Revenues have leapt 13.6% year-onyear, enabling companies to expand their margins, particularly those who have restructured their cost bases in recent years.
Higher oil and metal prices have made a particularly large contribution to the increase in revenues, though growth has been spread across a wide range of industries. Our index of UK revenues rose to 155.6*, meaning UK plc’s sales have jumped by more than half since 2007, rising almost twice as fast as inflation.
Having languished at post-crisis lows of 30.1* as recently as mid-2016, our index of UK profits soared to 116.6 by the end of June, meaning that profits have almost tripled in less than two years. Even so, the index shows that profits are just one sixth higher than they were in 2007, (or only 4.2% higher after stripping out the BAT exceptional gain), so they have lagged some way behind inflation over the last decade, and a long way behind revenues. To this day, in terms of margins, UK plc is still less profitable than it was a decade ago.
Progress over the last quarter has slowed somewhat, though it is still encouraging. The latest set of quarterlies and interims saw profits rise by 12.4% year-on-year on revenues that were 5.5% higher. The comparable figures a year ago had already begun to recover strongly, so it’s natural for the pace of improvement to slow. The latest results were also held back by the relative year-on-year strength of the pound. That means revenues and profits from abroad were translated at less favourable exchange rates.
Over the next year, the market expects median† or typical earnings growth of 6.7%, a marked slowdown on the recent performance. This looks achievable, but risks are rising. Growing global trade tensions, and less robust global demand than some had hoped, have already caused recent falls in the price of many commodities. These factors are contributing to slower growth, though renewed weakness in the pound will bring an exchange-rate boost if it is sustained. The total value of profits earned, however, is likely to decline 7.0%, as BAT’s exceptional profit washes out of the base. Our index will therefore show a brief dip before recovering again.
*2007 = 100
†The median is the rate of growth half way between the fastest and slowest growing company; it is not distorted by extreme values and is a helpful way of understanding the typical rate of growth companies are expected to achieve.
Pre-tax profits jumped 86% to £210.8bn in the year to the end of June, reaching their highest level since early 2012. The growth rate was boosted by a huge exceptional profit caused by the acquisition last year of Reynolds American by tobacco giant British American Tobacco (BAT), so not all that growth is organic. Without this effect, the increase was still an impressive 66%, however. Moreover, eight out ten sectors and two thirds of the UK’s listed companies posted improved results. This is very welcome. It’s a sobering reminder that the £703bn of additional revenue since 2007 has only generated an additional £31bn of profit.
UK plc’s profits declined continuously from 2011 until 2016, as successive shocks hit sector after sector. A crunch in the mining sector was followed by one in food retail, and the oil sector, while the banks continued to grapple with the aftermath of the financial crisis in the form of mounting compensation costs and fines.
By September 2016, UK company profits had fallen by 70% compared to 2007, the last year of the pre-crisis boom as squeezed profit margins were compounded by asset write-downs and heavy provisions: our index of profit flashed red at just 30.1. Since then profits have rebounded very sharply, with our index now back to 116.6, though if we exclude the BAT exceptional this would be a smaller, but still impressive, recovery to 104.5.
Share prices have recovered in tandem as investors reassessed the prospects for UK plc. Improved global growth pushed up oil and commodity prices, supported growing consumer and industrial demand, and helped banks repair their balance sheets. Many companies have undergone difficult and costly restructuring: lean cost bases meant a greater share of growing revenues is now turning into profit. The collective pre-tax margin of UK plc had fallen from 14.6% in 2007 to just 3.8% in 2016, lower even than during the 2009 recession. Over the last twelve months, by contrast, it has jumped back to 10.7%. Even if we strip out the exceptional BAT profit, the increase was to a healthy 9.6%, its highest since 2012.
The fastest growth has come from the oil sector, which delivered profits seven times higher over the last twelve months compared to the year before, but there was excellent growth from across UK plc, from banks to industrial goods & support. The healthcare and utilities sectors both delivered lower profits. In healthcare the biggest impact came from AstraZeneca, which suffered a margin squeeze on disappointing sales, while a host of problems for Centrica, including lost customers, regulatory uncertainty, and difficulties in North America, brought down the utilities group.
Analysts expect more bad news from Astrazeneca this year but in time anticipate the sector’s sales to turn around as new drugs come through the pipeline; meanwhile Centrica is expected to steady. The latest set of quarterlies and interim results saw pre-tax profits rise 12.4% year-on-year, led by the larger companies in the top 40. The slowdown in the rate of growth mainly reflects the fact that the comparable profit figures from a year ago were already recovering strongly – the balance of companies with higher profits is naturally getting smaller as a result of this. A stronger pound year-onyear also took the shine off the figures, masking better underlying growth.
Falling profits in healthcare had the biggest negative impact, with every company bar Shire reporting a weaker result. Overall earnings were down a touch for companies outside the top 40. This was due mainly to a poor showing for retail stocks (notably Marks & Spencer, Next, Mothercare, and Debenhams), as well as travel.
Brexit will pose unique challenges to UK based companies with one of the key factors being the direction of Sterling. The more domestically focussed companies will need much more clarity on the direction that negotiations are taking before committing to investment capital. The latest ministerial changes and the Brexit White Paper, which may not be to everyone’s liking, does help in some way ease the uncertainty, but this has not yet been enough for investors to fully take the plunge to invest in the UK.
Since the financial crisis, central bank’s accommodative policies and government’s fiscal and other supportive measures have helped economies in their steady recoveries, this has made equities the most rewarding asset class on a risk adjusted basis, albeit individual sectors have gone through their own respective challenges over this period. Central banks are now easing their support but this will only be at a moderate pace so as not to derail growth. Inflation is not racing ahead too aggressively to unduly pressurise policy makers to raise rates at a faster pace.
Global growth, despite expectations of slight moderation given political and world trade challenges, has nonetheless remained relatively good and still remains supportive for equities over other asset classes. Given rising revenues and profits in recent years it should be no surprise that stock markets are trading at all-time highs. We will however see periods of volatility in the market as we saw earlier this year as markets reassess growth and risks, but we still believe that over the medium to long term, with expectations of continued growth in revenue and earnings the equity market still represents the asset class of choice.