Fiscal tightening starts to squeeze company profits
Shares in Cable & Wireless Worldwide (CWW) shot down nearly 20% this week, after the telecoms giant warned that their full-year profits were likely to come in at the lower end of the forecasted range.
The company put the dip down to a sharp slowdown in UK public sector spending in the wake of last month’s emergency budget.
Other companies have also blamed lost revenue on the government. Housing company Connaught saw their share price tumble after warning that spending cuts would hit their results. But are investors being overly cautious, given the percentage of business that’s actually at stake?
Tremors in the market
It could be argued that the drop in share price is premature. After all, CWW’s revenue is still expected to fall within the forecasted range, and non-contracted work represents only 20% of CWW’s annual UK public sector revenues. According to Deutsche Bank, CWW derived 12.5% of revenue from public sector clients last year. Most of that business is contracted, but the 20% that isn’t enjoys the highest profit margin, and this is what has dried up since the Conservative-led coalition announced the £6.2bn cuts.
The real problem for CWW and other companies supplying the public sector, and indeed what is giving investors the jitters, is what will come next. The government may well move to renegotiate existing contracts on behalf of taxpayers. As Cabinet Officer Francis Maude bluntly put it before a meeting with the government’s 20 largest private-sector suppliers, 'We will expect you to tell us how we can pay you less, some of which will be for doing less'. [1]
What next for company shares?
CWW plans to combat the loss in earnings by cutting operating expenditure. But speculation is now focused on who will be next to feel the effects of fiscal tightening. BT is certainly a worthy contender, drawing 11% of group revenues from the public sector via their Global Service division – roughly the same proportion as CWW. IT services company Logica is also in a similar boat, as 15% of profits are drawn from UK government contracts.
But Capita, a key supplier to the government and named by David Cameron last year as a contractor which was getting too much work, led the FTSE 100 on July 22 after reporting a 15% rise in interim profits alongside strong demand across both the public and private sectors. Chief executive Paul Pindar said, 'Whilst the current pressures on public spending may potentially affect growth in the short term in a small number of our trading activities, the need for our public sector clients to achieve substantial cost efficiencies offers significant opportunities for the Group going forwards.' [2]
The drop in CWW’s shares this week suggests that investors are still unsure about the size and scope of the Conservative/Lib Dem coalition’s cost-cutting measures. Uncertainty about the medium-term outlook of public sector shares have lead to an investor pool that is easily spooked, and heavily influenced by the initial fluctuations in company earnings.
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Sources: [1] Bloomberg News 7 July 2010, [2] Capita website 22 July 2010
Updated: 22/07/10
The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.
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