UK businesses are bracing for a recession this year as they face the double whammy of slowing consumer demand and rapidly rising inflation-linked costs for their own businesses.
Several companies told the Financial Times they had started “war games” for a recession in recent weeks, with some adjusting their medium-term plans for a period of little or no economic growth.
Online used-car seller Cazoo was one of the first to specifically warn of the threat of recession last month, forcing it to cut hundreds of jobs. Shares of fast fashion makers Asos and Boohoo plunged after revealing increased product returns and warning of the impact of inflation.
Bosses said they are already seeing signs of a slowdown, particularly at retailers given the impact of rising costs on consumers. Electrical appliance retailer Currys slashed its profit forecast this week, while rival AO raised £40m in what its chief executive described as a ‘reasonable financial management element given the uncertainty short-term macroeconomics.
Stuart Rose, the former M&S boss and Tory peer, has warned that UK businesses need to prepare for tough times. “Most companies saw inflation coming. They have strengthened their balance sheets, taken appropriate action and will now take the hit on the margins. We will get there.”
A chief executive of a major supermarket chain said more people waited to do their monthly shopping around paydays. Other shoppers were telling cashiers to stop at a certain limit – £30 or £40 – to limit spending.
This has made it harder for the chain to decide on orders for larger items, such as clothing or electrical appliances, he added, with questions about how demand will hold up in the fall.
The supermarket boss described September as ‘come to Jesus’ month – when the need to spend on new uniforms and school items coincided with the end of holiday spending and rising energy costs.
A finance manager at a listed clothing retailer said the group was ordering less stock now for the fall and winter seasons given uncertainty over demand.
Many other businesses that rely on discretionary spending, such as travel and leisure groups, are also likely to be hit hard as a golden period of post-pandemic spending is expected to come to a halt after the summer.
Media and marketing groups are also considered to be among the most cyclical sectors of the economy, with advertising and related television and radio industries suffering rapidly as marketers cut spending during the downturns. previous recessions.
Martin Sorrell, executive chairman of digital marketing group S4 Capital, said the company “constantly reviews our revenue forecasts to ensure they are accurate” in light of changing economic conditions.
Sorrell expected a cyclical recession in parts of the world later this year or next. “It’s not deep, but it will take time to subside or change. The global slowdown is at the top of everyone’s agenda. People need to plan for a tough 2023. You need to focus now on growth and where you can find it geographically and technologically over the next two years.
Other City bosses – from Aviva’s Amanda Blanc to Fidelity International’s Anne Richards – also told the FT they were concerned about the growing risk of recession.
High inflation but high employment rate
The CBI has warned that the government has just weeks to change the direction of the UK economy, with recession now a “very real” risk as household spending falls.
“People know it’s going to be tough this year. They are falling given all the price pressures,” said Rain Newton Smith, chief economist at the CBI.
The latest gross domestic product data indicate the economy has slowed faster than economists had expected, while business confidence has fallen sharply in recent months. Analysts are already cutting earnings forecasts next year for the UK, Europe and the US, with some predicting widespread earnings downgrades and warnings of fall.
The continent-wide Stoxx 600 index is expected to post flat profits next year, according to Goldman Sachs, which was recently cut 5%, with a similar outlook for the UK.
These aggregate figures include sectors of relative strength such as oil and gas, which benefit from commodity prices.
According to an analysis of past recessions by Goldman Sachs, profits typically fall by around 30% at listed companies. The worst recession in recent times was the 2008 financial crisis, when profits fell 50%, but the bank did not expect that to happen again, according to UK portfolio strategist Sharon Bell.
“We had financial imbalances at the time, the corporate sector was very over-leveraged, the banking sector was not as well capitalized and even households were quite stretched.”
Peel Hunt said this recession could be unusual due to high inflation which “will have a significant impact on disposable income”, but also high wage and job growth.
Goldman suggested the hardest hit businesses were generally travel and leisure. “That’s what people cut first,” Bell said, pointing to a combination of higher rates, lower savings and higher costs due to the rising energy price cap and other inflationary factors.
“All of these things are going to happen around Christmas. The first quarter earnings season was good. The second quarter will probably be good too. Real success will be more likely in the third or fourth quarter of this year. »
Peel Hunt also cautioned against consumer-related sectors in hospitality, where spending can more easily be cut.
“If consumers are going to drown their sorrows in the next recession, the hospitality industry will have to work even harder to win over its customers,” he said in a note highlighting the essence of home drinking. .
“Overall, the economic picture looks grim for the consumer over the coming winter, with the impact of inflation disproportionately affecting lower-income groups.”
Real estate and construction services have been hit harder in previous recessions, with rents and capital values tending to follow economic growth and construction dependent on demand for new housing.
Less cyclical include healthcare, utilities, tobacco and consumer staples, such as staple foods.
“People can trade their groceries, but they’re still going to buy them,” Goldman’s Bell said.
“Everyone has to eat,” added a supermarket boss, who noted consumers were starting to shift more to own-brand foods, and predicted tougher sales of more expensive clothing and electrical appliances.
But even food producers and retailers that normally weather periods of declining consumer demand will be hit by pressure on volumes and profit margins given the sharp rise in food inflation, according to Peel Hunt.
Tesco and Sainsbury’s have said they expect lower profits this year as they absorb some price increases to cut costs for shoppers.
Pointing to beverage makers such as AG Barr and Britvic, the broker said such strong brands stand to benefit as the consumer polarizes between high-end and value, with the middle squeezed.
However, he said drinks mixer Fevertree was likely to “come under some pressure in a recession”.
Banks appear more resilient today than in 2008. At a time of near full employment in the UK, there are few signs that people are struggling to pay their mortgages, while rising interest rates interest could also help their businesses.
However, RBC Capital said big banks could still be hit if consumers face a “triumvirate of higher food, energy and mortgage costs” during a recession.
While sectors such as telecommunications and utilities are heavily leveraged, they are also considered strong cash generators and largely essential. The boom in locked pets, meanwhile, could also support sales in the pet care sector.
“Most consumers prioritize their pets over spending on themselves,” according to Peel Hunt. “We’ve always thought the last three things to ‘do’ in a recession are the Sky Sports subscription, the monthly new pair of trainers and the dog.”