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Two-Tier Economy Looms for UK: Analyst

Tuesday, 11 Oct 2011 | 9:53 AM ET

A two-tier economy is emerging in the UK, with small-cap companies being left behind, Keith McGregor, EMEA head of restructuring at Ernst & Young, told CNBC Monday.

UK Two-Tier Economy Emerging?
"Three-quarters of the warnings for this quarter [in the UK] are on small cap companies. There is an emerging tail of a two-tier economy," Keith McGregor, head of restructuring EMEA at Ernst & Young, told CNBC.

Of the 51 UK-quoted companiesthat issued profit warnings in the third quarter, three quarters were companies with a turnover of less than 200 million pounds ($313 million). McGregor said such firms were both insufficiently capitalized and struggling to grow, due to low consumer demand.

“There is an emerging tail of a two-tier economy,” he said. “Large companies that are well capitalized, and have deleveraged over the last few years, their problem is about where to find growth. The smaller caps are struggling with both the growth equation, and the capital equation.”

McGregor said that anemic demand was now a bigger impediment to profit than costs.

“This is not about cost anymore. Only 1 in 6 of the warnings was to do with cost pressures, compared with 1 in 3, a year-to-day. This is about demand,” he said.

While profit warnings were 28 percent lower in the third quarter than in the second quarter (see above), with 51 rather than 64 warnings, McGregor said, “This is not necessarily about profits improving; it is about vastly reduced expectations being undercut.”

He added: “The market is punishing those that still get it wrong, with an 18 percent drop [in share prices] on the day of a profit warning, on average.”

According to Ernst & Young’s report on third quarter profit warnings, called "Profit warnings fall, but there’s a sting in the tail", share prices are more negatively affected by profit warnings during periods of uncertainty.

“Heightened uncertainty encourages investors to de-risk their portfolios and profit warnings certainly met with a heavy punishment this quarter,” said the report, adding that share price fall-offs following profit warnings were at their largest since 2008.

The FTSE sector with the highest proportion of warnings last quarter was construction and materials. In total, 15 percent of the FTSE Construction & Materials sector warned in the third quarter of 2011, whilst 25 percent have warned in the last 12 months.

“Construction’s budding recovery is starting to stall. The impact of the slowdown is patchy. Some companies and sub-sectors continue to outperform, but construction insolvencies are rising and a revenue and pricing squeeze continues to claim casualties,” said the E&Y report.

Also struggling were UK-listed beverages, with 14 percent of companies warning in the third quarter, and food and drug retailers, with 10 percent of companies issuing warnings.