Cuts could reverse recent fall in profit warnings

PROFIT warnings in Yorkshire and the North East fell sharply in the first half of this year, but impending cuts in public spending could reverse the positive trend, according to a Big Four accountancy firm.

Ernst & Young said six warnings were issued in the region in the second quarter of 2010, compared to 10 in the same period last year. The first six months had 12 warnings in total, down from 29 in the first half of 2009.

The situation in Yorkshire and the North East matched the national trend with 45 profit warnings from UK quoted companies in the second quarter of the year, a near seven-year low.

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Analysis of the warnings shows far fewer companies are blaming macro-economic conditions. Less than a quarter blamed difficult trading conditions, compared with nearly half in the same period last year.

Instead, many companies blamed contract amendments or cancellations, some of which were early victims of government spending cuts.

Hunter Kelly, a restructuring partner at Ernst & Young in Yorkshire, said the fall in profit warnings was due to the cautious approach of management teams.

The cautious trend is likely to continue in the face of forthcoming austerity measures, the hike in VAT, the cancellation of school-building projects and problems in eurozone countries such as Greece, he added.

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"The economy is as flat as a pancake. Nobody is talking anything up. Everyone is talking everything down," Mr Kelly said.

"Companies are setting a lower expectation with City brokers, therefore market information is being set at more cautious levels so they don't need to warn the market. Are businesses doing better or worse? It's difficult to say but they are managing expectations better."

The sectors in Yorkshire and the North East to issue warnings last quarter are: electronic and electrical equipment; general retailers; healthcare; equipment and services; media; mining; and technology hardware and equipment.

Looking ahead, Mr Kelly said: "UK plc could be in for another rough ride; this will be the last period in which the UK's expansionary fiscal policy will help.

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"A number of companies have already cautioned that they expect much tougher times ahead, when fiscal tightening reins in public sector and consumer spending."

He added: "It looks like 2011, rather than the second half of 2010, will be the crunch period. It is then that the extra 40bn of fiscal tightening, including the rise in VAT, will likely coincide with the upslope of a refinancing peak.

"Add to this the effect of the headwinds from the eurozone, stuttering credit markets, and possible interest rate rises and you can take a very pessimistic view.

"A question mark still hangs over the ability of both investment and exports to build momentum in the rest of 2010. Access to credit is also a vital prerequisite for a strong private sector recovery, but the fears over the viability of the eurozone and the solvency of some members, is limiting bank credit and periodically slamming the bond market door shut."

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Big spending in the public sector and fiscal stimulus helped to provide a buffer for many companies against the worst of the credit crunch and recession.

The withdrawal of this spending will hit the support services sector the hardest, said Mr Kelly.

He added: "This leaves UK plc with a very difficult hand to play. Many companies are now enjoying reasonable trading and preserved cash, which explains the exceptionally low levels of warnings in some sectors.

"However, given the challenges to growth, companies will need to continue to manage costs and expectations carefully, when the retrench in government spending really starts to hurt."

Dampening hopes of recovery

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The prevailing uncertainty and demand volatility means that profit warnings are likely to increase in the year ahead, according to Ernst & Young.

Hunter Kelly, a partner, said the withdrawal of public spending would impact on the private sector in 2011, an assessment which will dampen the expectations of those who hope for the economic recovery to pick up pace next year.

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