The big UK earnings crunch is still to come

At least you can count on Deliveroo to disappoint.

In its short listed life, the group’s shares have shed three-quarters of their value. That is despite previously having upgraded sales estimates and laying out plans for the lossmaking company to break-even by 2024.

The cut to sales growth forecasts on Monday was, by this point, entirely predictable. Deliveroo is almost the definition of the consumer discretionary spending being squeezed: a takeaway that by the time various fees are added feels almost as expensive as eating out.

Throw in tricky year-on-year comparisons, with figures last year flattered by restaurant closures. Investors already dumped the shares as unprofitable growth stocks fell from favour. It’s not much comfort that Deliveroo expects to lose less this year because it expects to grow less, even if the shares edged ever so slightly higher.

Monday’s other profit warning points to the wider looming problem. This one came from insurer Direct Line, and related not to demand pressures but cost ones.

True, there are some peculiarities affecting the motor insurance market. Car prices — which affect claims costs, Direct Line’s problem — have risen particularly fast over the past two years. Rules stopping insurers from incrementally raising renewal quotes for loyal customers each year are forcing adjustments to pricing models, and premiums have yet to catch up to claims inflation. There are signs that is starting to change, but not quickly enough for this year’s earnings.

But other businesses have labour and energy costs to contend with. Between them Deliveroo and Direct Line could be seen as the two sides of a pincer movement on corporate profitability, with earnings caught between falling consumer demand and rising costs.

This is increasingly the narrative in the US. Analysts holding off on downgrades to forecasts have thrown in the towel since the start of July. “Earnings momentum”, the proportion of upgrades as a percentage of total changes in estimates, “has slumped toward levels usually associated with a profit decline” over the past few weeks, noted Andrew Lapthorne of Société Générale in research published on Monday.

But by and large it’s not, yet, the story for the UK. Profit warnings have been mild so far, despite Deliveroo and Direct Line on Monday and the likes of Ocado, Wizz Air and Wetherspoons before them. EY data show 136 warnings from UK listed companies in the first half of this year, more or less in line with the 10-year pre-Covid average of 134. In Citi’s “earnings revisions index”, which tracks changes in analysts’ forecasts, the balance of downgrades compared to upgrades is less bad for the UK than the US, emerging markets or the rest of Europe.

Are UK companies really less exposed?

Simon French of Panmure Gordon laid out three possible explanations for the UK’s downgrade discrepancy when he looked at it last month.

The first was that UK earnings estimates for 2023 were already more gloomy than their US or European peers at the start of the year. The second, that the tilt of the UK’s stock market towards energy, mining and other value sectors made it more resilient to rising interest rates and high inflation, though he noted that UK companies had suffered fewer consensus cuts across a wide range of sectors. The third was that patchy research coverage, particularly of smaller UK companies, could be to blame. If that’s the case, the UK could have catching up to do — though French reckons the fact UK forecasts were more modest to start with means downgrades here will lag at the market level.

The other counter to any UK bulls out there is that the consumer crunch hasn’t really arrived yet. The start of the fourth quarter, when the domestic energy cap is due to rise again just as households want to turn on their heating, is when things get really bleak — and consumer-facing companies realise there’s no way they can make their full-year forecasts.

Deliveroo is at the vanguard of consumer cutbacks. Direct Line should serve as a reminder that companies beyond the consumer sector are about to feel the squeeze.

cat.rutterpooley@ft.com
@catrutterpooley