What could the listed company profit warnings mean for smaller businesses?

What could the listed company profit warnings mean for smaller businesses?

November 2, 2022

Doing business with big corporates will almost always have its challenges for smaller companies, but the credit risk and supply chain risk are rarely issues that keep entrepreneurs awake at night. These large entities can be excessively demanding and have a reputation both for slow payment and for exploiting the imbalance of power with their SME trading partners, but the mere fact that they are listed on the Stock Exchange generally implies that they are creditworthy and here to stay.

So what should the lower tiers of the business world make of the latest figures from EY Parthenon for profit warnings issued by UK listed companies in Q3 2022? They reported that there were 86 listed company profit warnings in those three months, an increase of a third on both Q2 2022 and the pre-pandemic quarterly average and the highest Q3 total since 2008.  There have already been 223 profit warnings in 2022, higher than the total of 203 for the whole of 2021. The totals for 2019 (313) and 2018 (287) look certain to be beaten.

Underlying factors

Whatever is happening to UK Limited, it seems that all is far from well with UK PLC too. 57% of these profit warnings cited cost increases as a factor and 23% blamed labour market issues. Other less major factors include supply chain disruption, weaker consumer confidence and exchange rate changes.

Rising interest rates

None of this will be news to those running smaller companies, but what is worrying is that the explosion in borrowing costs over the past few weeks has not yet registered in these warnings, but will surely do so in Q4 2022 and on into 2023.

Interest rates in the UK and around the world have increased faster than at any time in the past 41 years, according to analysis in late October by S&P Global Ratings. This will come as no surprise to SMEs. One in five small businesses, which applied for finance in Q3 2022 failed to find an offer at an interest rate below 11%, according to a survey of Federation of Small Businesses (FSB) members.

Which sectors have experienced the most profit warnings?

Just over half of the warnings in Q3 2022 came from companies in consumer-facing sectors. There were 11 retailers, 9 in travel and 7 in food production. There were three in the personal care, pharmacy and grocery sector and another three personal goods. But problems are clearly building in other sectors, such as banking and broking (5), IT (5), property (3) and construction (3).

Are all profit warnings equal or are some more worrying than others?

EY has focused on the ‘three strikes and you’re out’ aspect of profit warnings. Pre-pandemic, their research showed that 12% of listed companies that issued three or more profit warnings in a twelve month period had to go through a formal restructuring process within a year of their third warning and another 20% had de-listed from the stock exchange on which they were quoted. By mid-October 2022, just after the end of Q3, there 28 listed companies on their third or more warning, a major increase from 18 companies only three months earlier.

A formal restructuring process may involve an equity raising exercise or a sale process, but it could also mean going into Administration or a Company Voluntary Arrangement (CVA). There is a strong likelihood that all of these procedures could involve losses for some or all of their creditors and supply chain disruption for their customers.

Even those companies not forced into a formal restructuring or only on their first or second warning represent an enhanced risk for their trading partners. Their management will inevitably take remedial action, which might involve seeking extended credit terms from suppliers or increasing prices and dropping product or service lines, potentially disrupting their customers’ business models.

Related article: Which sectors are most affected by corporate insolvencies?

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Credit insurers

Trade credit insurers have been reducing their exposure for a while in anticipation of the recession that has probably now already started, a step that can have dramatic effects on a company’s cash flows where they limit cover or pull it altogether. Issuing a profit warning could impact the cover for trading with even the most prestigious listed companies.

Suppliers faced with less protection from trade insurers must beware giving in to requests to continue to supply on previous terms. If the cover has been removed at all, the only safe basis for continued trading will be cash in advance. Bad debts with large corporates can be devastating. Even a £10k write off for a business with a 10% profit margin means finding an extra £100k of sales to make good the loss. The impact of an £100k bad debt could be terminal.

Other key stakeholders

Other areas of ‘soft’ credit, such as cash advances from credit card processors or by invoice discounting companies might be affected by the issuing of a profit warning. This too will reduce cash flow and could precipitate a crisis.

What should smaller businesses do when a profit warning is issued?

The obvious and very first answer is not to ignore it, nor to accept reassurances from the listed trade partner without asking some pretty direct questions. They will not normally want to lose customers or suppliers, which could give SMEs the upper hand in negotiation.

It will be essential to do as much due diligence as possible about the situation, using trusted business information sources online, from trade associations and fellow suppliers or customers. There is a vast array of information in the public domain about large listed companies, most of it available from a range of data suppliers and credit analysts.

Most of all, smaller businesses need to mitigate their exposure to the listed company and do it as fast as possible. Allowing the receivables balance with them to mushroom beyond normal credit terms is certainly not advisable in the current economic conditions.  Nor is it a good strategy to be the last customer in your market left standing when the listed company stops supplying, after your competitors have already made alternative arrangements.

If the potential damage to your business is significant, it may be sensible to take advice about the situation from outside business specialists. They are well versed in these situations and know how best to limit damage and can outline the options available to you. Having an independent expert voice on your side in discussions with the listed company can have major benefits.

If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.