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'Earnings recession' as blue-chip and mid-cap profits fall

4 November 2019

FTSE 100 and FTSE 250 profits fell 4.5% in the third quarter, the first drop in almost three years, according to The Share Centre.

Blue-chip and mid-cap stocks have entered an 'earnings recession', with quarterly profits falling for the first time in more than three years, according to The Share Centre.

The latest Profit Watch UK report paints a worrying picture for companies listed on the UK stock market as they struggle against the effects of Brexit uncertainty and a broader global economic slowdown.

Profits from FTSE 100 and FTSE 250 stocks fell 4.5% in the three months to the end of September, the first quarterly drop in almost three years. Over the past year, profits have declined 1.6% to £189.7 billion, meaning UK profits have grown just 7% since 2007, ‘far behind’ revenues.

In the past year, revenue has grown 6% to just over £2 billion and in the third quarter it was up 4.6%, which is a ‘low quality increase’, said The Share Centre analyst Helal Miah, as two-thirds was due to the ‘flattering effect’ of weak sterling.

Oil and mining stocks contributed two-fifths of all the revenues reported in the quarter.

‘The oil majors held the sterling value of their revenues flat, yet were lower in dollar terms, owing to lower oil prices year-on-year,’ said Miah.

‘Mining groups were among the strongest performing sectors with many benefiting from higher volumes and exchange-rated effects, even though prices are under pressure for some commodities.’

Banks, travel, and IT companies reported the best revenue growth, with banking boosted by Royal Bank of Scotland (RBS) and Standard Chartered (STAN). However, Miah said banks were reporting tougher conditions as net interest margins – the difference between what banks pay in interest on savings and what they charge in interest to borrowers – contract.

Property suffered lower revenues as estate agents complained about a slow housing market and property investment businesses were hit by falling commercial property values. Utilities are also under pressure from government price caps and general retail is ‘a good example of how annualised sales growth has roughly kept pace with inflation… but securing customer cash has come at a heavy cost’ as profits fall.

‘The narrowing of collective profit growth onto fewer and fewer companies in recent quarters has finally run its course, exposing a margin squeeze that has spread out across most sectors and companies,’ said Miah.

He said UK shares were now starting to show value and ‘even though earnings expectations are too high, valuations for UK companies are well below both their international peers and historic levels’.

Miah said this value was illustrated by the yield available on UK companies, which has only dropped slightly from its January peak of 4.8% - the highest since 2009. UK shares currently yield a collective 4.4%, well above the 3.5% historic average.

‘Though the current disconnect between dividends and share prices doesn’t mean prices will rebound anytime soon, strong yield performance does suggest that equities still present very good value in the long term,’ he said.

Analyst profit predictions for this year is growth of 3.3% and 8.6% next year but Miah said these were too high as companies are struggling against Brexit, structural changes in retail, and the slowing global economy.  

‘In the coming weeks and months, we may see pent-up investment capital being released and put to work as the Brexit deadlock has hopefully been broken with a reversal in performance between the UK focused and small cap companies compared to the global multinationals,’ he said.

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