Sterling bites deeper into profits

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British industry’ profitability continued to crumble into the first quarter of 2000. According to information solutions company Experian in its latest Corporate Health Check, the average return on capital – a leading measure of profitability – has fallen four quarters running, to 12.61% in the 12 months to March 2000, after peaking at 14.18% in the previous 12 months.

“The UK economy is still growing strongly in terms of gross domestic product,” said Peter Brooker of Experian, the author of the report, “but there is growing divergence between the manufacturing and service sectors. Manufacturing growth has slowed to a trickle, while the service sector is still growing at around three per cent. However, profitability in both the manufacturing and service sectors is down as companies across all industries have been unable to improve productivity and reduce costs sufficiently to offset the continuing strength of the pound and rise in the price of oil. The average profitability of British industry has now fallen by more than 11% in 12 months.

“Even after inflation is taken into account, the real level of profitability has fallen from 12.63% in the second quarter of last year to 10.01% in the first quarter of 2000 – its lowest level since the beginning of 1998.”

The success of a small number of industries last year masked the extent of problems caused elsewhere by the strength of sterling. Now, those difficulties are affecting virtually every manufacturing and service sector, export-led or serving domestic markets. Despite a small number of sectors improving in the first quarter of the year, of the 23 industries analysed in the Health Check, 21 have seen their profitability fall during over the last 12 months, in several cases by more than a fifth. The exceptions were alcoholic beverages (which rose from 9.81% to 11.07%) and food retailing (which rose from 14.09% to 15.56%).

Exporting manufacturers are suffering the greatest problems, with chemicals (down from 10.78% to 8.81%), pharmaceuticals (down from 35.49% to 26.74%), print and paper manufacturing (down from 12.99% to 10.55%), textiles (down from 8.92% to 7.28%) and diversified industrials (down from 20.85% to 17.52%) all declining by around one fifth across the year.

Some service sectors have now joined this group of industries with sharply reduced profitability, including distribution (down from 14.15% to 10.67%), support services (down from 26.05% to 20.56%) and transport (down from 10.21% to 7.34%).

Profitability fell in every part of the country, and only the West Midlands, the UK’s most profitable region, is ahead of the same period a year ago. There is some evidence of a growing North/South divide, with Scotland and the North West suffering the greatest year-on-year and quarterly falls in profitability, as well as levels of profitability well below the UK average.

“The real divide is not between North and South,” said Peter Brooker, “but between the central belt from the north of England down through the Midlands to the South East, and the ‘fringes’ of Scotland, Wales and East Anglia. These three regions all lie at the bottom of every regional ranking of measures of profitability.

“Scotland and Wales have seen the demise of traditional industries, such as ship building, mining and steel and have attracted investment in new industries. Unfortunately, many companies in these industries have been hit by the strength of the pound, which has caused Japanese manufacturers, in particular, to express concern over the future of their investments in the UK.

“According to recent business surveys, manufacturers across all parts of the country are being forced to scrap or cut back investment plans – shown by the downturn in imports of capital goods in the early part of the year – and cut recruitment as they are hit by falling orders, particularly to the European Union. It is only the recovery in Asian markets and the strength of the US economy and currency over the last year that appears to have enabled orders and exports to grow in some parts of the British economy,” said Brooker.

Experian is also warning that many companies which took advantage of lower interest rates over the last couple of years to increase their borrowing will experience difficulties in servicing their debts from lower profit levels should interest rates rise again later this year. This will inevitably lead to an increase in the number of insolvencies.

Profitability increased in just six sectors in the first quarter of 2000: building materials, chemicals, health and household goods, hotels and leisure, and food retailing. All except food retailing are still well below the levels of profitability they achieved at the same time last year.

The pharmaceuticals industry, which has seen profitability fall by a quarter over the last 12 months, has been toppled from its position as the most profitable industry by the health and household goods sector.

Peter Brooker concluded, “The decision by the Bank of England not to raise interest rates for the last few months has not led the pound to weaken. Many companies have held down prices and squeezed margins by driving down average unit costs and raising productivity. Many have also been steadily reducing their workforces; 13,000 manufacturing jobs were lost between December 1999 and February this year, with the result that employment in the manufacturing sector is now more than three per cent below the level of a year ago.

“Productivity improvements over the last year have mitigated some of the competitive pressures forced on British companies by the strong pound but manufacturing confidence, in particular, is still low. Overall output in the UK appears to have made some recovery since slowing sharply at the start of the year but there has been no real change in the fundamentals – cheaper imports, inflationary pressure on producer input prices, particularly from dearer oil, with little opportunity for companies to pass on these rises, weak retail sales, falling manufacturing investment and subdued manufacturing output – make the prospects for a reversal in the declining trend in profitability among UK companies look unlikely for the remainder of the year.”

The Experian Corporate Health Check is based on the audited financial results of the 2,000 largest companies in the UK and reflects the combined effects of current UK economic policy and market conditions on the actual financial results of British companies. Experian’s Business Information database, the largest of its kind in the UK, holds the same data on every limited company in the UK.

The Experian Corporate Health Check is based on the audited financial results of the 2,000 largest companies in the UK and is compiled in association with Nottingham Trent University Business School. The report reflects the effects of UK economic policy and the performance of the UK’s trading partners on the financial results and profitability of British companies.

Experian

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