Profits panic doesn't spell doom for all

THE RUN of profits warnings that rocked the stock market last year has shown little sign of slowing in 2002. But close followers of the equity markets believe that most of the warnings stem from isolated company and industry problems, rather than being symptomatic of a wider economic malaise. This has helped foster confidence among some that stock market conditions will improve over the next six to 12 months.

'At this stage of the cycle, you would expect to see profit warnings but we have probably seen the worst of it,' said Deutsche Bank strategist Bob Semple. Those holding shares in the five companies listed here would certainly hope so. These groups are among those who have made it a rocky start to 2002 for investors exposed to the equity market. But their profit warnings have had little in common.

EMI shareholders have been left to sing for their supper in the past year, with the stock sliding about 40% as the world music market shrinks. The company has issued two profits warnings in five months, telling tales of underperformance in the US and tough times in Asia.

Many of EMI's problems stem from the explosion in CD piracy, as reflected by soaring sales of blank CDs in some parts of Europe, particularly Germany. Analysts are split on whether 2001 will prove to be the trough.

EMI's more bullish followers argue piracy has reached saturation point, with most of those who want to copy CDs having already done so. But others believe the practice will grow as broadband technology cuts the time taken to commit the crime from hours to seconds.

'The question for investors is 'will EMI's planned restructure, which is due in March, be sufficient to counter the ongoing effect of piracy?',' said JP Morgan analyst Nick Bertolotti.

The company has also been hit by the weak Japanese economy and comparisons with its performance in the 1990s, when the music industry was boosted by the switch from vinyl records to CDs.

Pearson, the publishing group, has seen profits hit by lower advertising expenditure and cuts in corporate training budgets. Expenditure on both is effectively an investment by Pearson's clients. It often takes time to get a return on this money and, even then, the results can be difficult to measure.

Marketing budgets, from which advertising expenditure is derived, are one of the first items to be cut in a downturn, as Pearson's Financial Times found in the middle of last year. By October it warned that profits at the FT Group would be down 40% and three months later it said profits at its education business would be lower than forecast as companies cut back on training.

But analysts point out that much of Pearson's education business is relatively defensive. This, combined with a forecast upturn in advertising expenditure, is expected to underpin a substantial recovery in profits this year.

Cordiant blamed a slump in advertising for three profits warnings in four months. The last one, at Christmas, spooked investors with suggestions that there was no sign of recovery. Chief executive Michael Bungey believed then that the advertising and marketing downturn had reached 'unprecedented severity' with projects and campaigns being cancelled around the globe.

Cordiant shares have since slumped another 20%, suggesting a turnaround is as far away, if not further, than ever.

Merrill Lynch analyst Tom Deitz said the loss of the Hyundai account in the US had fuelled concerns about whether the group had the financial strength to tough out the downturn. 'This will be another tough year for all the agencies,' Deitz said. 'There is price pressure out there and a lot of account consolidation going on.'

Energis shareholders are also justifiably worried about their company's survival prospects. The telecoms group, which installs its cables on existing electricity pylons, last month issued its third profits warning in six months and warned it may breach banking covenants.

Analysts say many of the company's difficulties are a direct result of a competitive market in which prices are being squeezed and customers with problems of their own are not buying the value-added services offered by Energis.

'The market is tied up and they are fighting for the scraps,' said one analyst. 'It makes it hard to get the contracts Energis needs to expand to the next level.'

Energis is expected to announce the results of a strategic review within a fortnight. Its options include a sale of the business, a rights issue and the closure of some overseas operations.

Royal & SunAlliance shareholders would have considered the insurer to be among the last to issue a new year profits warning. The sharply higher premiums that have flowed from the events of 11 September are sure to have left many feeling relatively comfortable about the outlook.

But RSA ended the complacency by warning that a huge rise in provisions for claims relating to asbestos diseases would do no better than break even this year against a £476m profit previously.

It said that reserves for asbestos claims had been more than doubled to £689m and it had set aside a further £175m for other claims. But some followers believe there could be more to come, saying this uncertainty was overshadowing the benefits of higher premiums and the company's success in the reinsurance market.