Long way down for ‘Icarus’ stocks as profit warnings turn up the heat
Not all stocks defied gravity in 2017. While some City and Wall Street analysts fretted about “Icarus” stocks flying too close to the sun, as the global benchmark indices climbed to record highs, some in London have already fallen out of the sky.
Shock profit warnings and share price plunges are part and parcel of the stock markets, but nosediving shares in the UK haven’t known when to stop this year. While the overall number of profit warnings is on course to have fallen in 2017 compared with a year ago, the resulting share price plunges have become markedly more extreme in the second half of the year, according to data compiled by Ernst & Young.
London stock market stalwarts, including WPP, Astrazeneca and Dixons Carphone, have been slayed by warnings on everything from digital disruption to drug trial failures and consumers holding on to mobile phones for too long.
The figures indicate that the 350 largest listed companies have faced the brunt of investor intolerance to revised expectations, with share prices tumbling on the days profit warnings were issued by an average of 16.2pc and 15.4pc in the third and fourth quarters, respectively.
By way of comparison, the average share price fall in the FTSE 350 in such circumstances in 2016 was 11.1pc and in 2015 just 9.4pc.
Analysts argue that frothy stock valuations have exaggerated the falls. The higher they rise, the further they have to fall.
“Valuation is a factor. But the highest falls have come in sectors under greatest structural pressures – for example, increasing online competition, regulatory change, rising costs, pricing pressures etc,” says Kirsten Tompkins, an Ernst & Young analyst. “It could be that investors are treating these warnings as a sign of deeper issues, rather than a one-off.”
The outsourcing and retail sectors have had the lion’s share of profit warning plunges this year. Inflation outstripping wage growth at an ever-quickening pace in 2017 and consumer confidence sinking on Brexit blues have turned up the heat on the retail sector.
Bellwethers of the British high street, including Next and Dixons Carphone, have seen profits shrink as sales stutter on squeezed discretionary incomes.
“The pain has been particularly keenly felt by those selling high-ticket items,” argues Hargreaves Lansdown analyst George Salmon. “Unfortunately, new sofas, phones and TVS are all discretionary purchases that typically require a bit of planning.”
He adds that the worry for the beleaguered sector is that not only will uncertainty continue to knock consumer confidence, but the inevitable march of e-tailers could spell the demise of the high street altogether.
Recent data from Nomura indicates that the UK already leads the push online, with 15.7pc of retail trade in Britain already online, compared with 10.9pc in the US and 9.8pc in the eurozone.
Investors who have attempted to – as the traders’ saying goes – “catch a falling knife” this year by picking stocks after a profit warning, believing that they have bottomed out, have often ended up with bloody hands. HS2 and Ministry of Defence outsourcer Carillion initially slipped 39pc after counting the cost of soured contracts and axing its dividend but then continued to plunge. Its share price has tumbled by more than 90pc this year, slashing its market value from a peak of £1bn to around £70m.
Carillion’s woes have been indicative of a struggling sector with peers Babcock International, Capita, Mitie and Interserve also sinking as long-term contracts agreed with paper-thin margins ran into problems. Higher exposure to the UK economy for revenues and mispriced contracts have also sent the sector’s stocks sliding, according to Mr Salmon.
Doorstep lender Provident Financial, the second-worst performing stock on London’s main market so far this year after Carillion, shed 70pc of its value not on its failure to adapt to a changing sector but the failure to do it well.
A botched revamp of its home credit arm dealt the first blow but another profit warning and the revelation that two FCA investigations had been launched sent its market capitalisation spiralling from £4.8bn to as low as £870m.
IG chief market analyst Chris Beauchamp argues share price slumps have been worsened by stocks becoming less liquid as international investors move money out of riskier UK equities. He describes London as one of this year’s “unloved markets” and says investors have avoided UK stocks due to the gloomy domestic outlook.
He added: “The great thing about mid-caps is that they often do outperform the big FTSE 100 stocks but you also have that risk that a lot of their business is Uk-focused, whereas for internationally focused stocks weakness in one area is relatively easy to offset by performances elsewhere.”
As 2018 dawns, the trends underpinning the sharp falls show no signs of slowing.
The Bank of England believes that inflation will ease at an achingly slow pace in 2018. There are no flashing warning signs indicating that lofty stock valuations will crash or, at the very least, correct. And tectonic shifts within sectors are unlikely to reverse.
Brexit breakthroughs and cooling valuations could be the main catalysts stopping stocks imploding in 2018 but, for those being left in the dust by sweeping structural changes, they will only soften the fall.
‘The pain has been particularly keenly felt by those selling high-ticket items. Sofas are discretionary purchases’