Investors should be braced for a series of profit warnings in the final quarter of the year as analysts pare back over-optimistic estimates against the backdrop of a deteriorating economic environment, Smith & Williamson Investment Management’s Mark Swain has said.
Following poor data from major global economies including the US, China and Europe, in particular for manufacturing, a number of companies’ share prices now appear vulnerable in the UK as we near the end of the year.
Swain, who manages the Smith & Williamson Enterprise Fund with co-managers Mark Boucher and Rupert Fleming, expects a number of profit warnings in the final quarter to rock some of the UK’s manufacturers.
“The data that is coming out now in terms of PMIs and other readings means it is likely we will get some big profit warnings in the final quarter of 2019,” he said.
“This is a typical event anyway as optimistic expectations set at the start of the year are revised downwards at year-end, but this year in particular we expect it to be worse given the slowdown from Brexit uncertainty in the background.”
“In terms of those likely to be worst affected, the UK’s manufacturing and industrial sectors have plenty of names which look over-stretched in terms of the valuations they currently command.”
Swain noted some of the companies were still trading on P/E ratios of 25 times or higher.
“Some of these businesses – be they manufacturers, capital goods or industrials – are very highly-rated by investors and if they warn on profits it could be a very sharp de-rating,” he said.
“In short, we think there could be some absolute howlers out there, and we think these are the sectors where the pain will really be felt as we move through Q4.”
Some of these shares face a potential double-whammy if they do miss expectations, Swain added, because analysts’ forecasts for next year are yet to be lowered.
“Some estimates have fallen in terms of this year’s final numbers, but forecasts for next year look far too high as it stands. Targets for next year are implying a hockey stick recovery in activity, and we are simply not going to get that.”
On the positive front, Swain added a combination of weak sterling and cash-rich foreign companies with strong balance sheets could lead to a jump in M&A.
“The UK is still home to very good companies, and we expect M&A to be a key theme as a result,” he said.
“There lots of positives from the perspective of overseas buyers, not least their balance sheets, which are generally healthy, and the weak pound. Even at $1.28, the pound is way down on pre-Brexit levels. Quality UK companies are therefore very attractive to overseas buyers now.”