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Chris Birks
Chris Birks

The near-perfect storm for UK plc

This article was published in Informed magazine, the quarterly journal of the IR society.

Few companies are entirely insulated from current inflationary forces. Chris Birks explains what IR can do to communicate the impact.

During the height of the Covid-19 pandemic, listed companies were given extra flexibility around deadlines for financial reporting by the Financial Conduct Authority and the Financial Reporting Council. During this time many companies withdrew their market guidance citing the problems of forecasting during such volatile and ‘unprecedented times’.

With the pandemic now largely behind us, the relaxations on financial reporting have been withdrawn and investors expect companies to provide accurate and timely guidance to the market. However, rather than the expected return to normality, we have entered a new period of economic uncertainty and volatility, exacerbated by the fragility of global supply chains, Putin’s war in Ukraine, the extreme volatility of commodity prices (particularly energy costs) and double-digit retail price inflation. One could argue that current market conditions are equally as ‘unprecedented’ as those experienced during COVID.

Back to the future

Three years ago, investors were concerned about the spiral of deflation and negative interest rates, while they are now fretting about a return to the economic landscape of 30 years ago with systemically embedded inflation where the authorities’ main weapon is the blunt instrument of raising interest rates. The fallout from the Truss administration’s mini-Budget last autumn has added a sterling crisis and a mortgage famine into the mix, thereby creating a near-perfect storm for UK plc.

Amidst this backdrop of extreme uncertainty, listed companies have to run their businesses, do their own internal budgeting and forecasting and provide timely updates to their shareholders and the market.

“It is now obvious that the era of low inflation and low-interest rates is a thing of the past and that high inflation across many categories may be with us for the foreseeable future”

Given this, we thought it was a good time to look at how some companies have been updating the market on the effects of price inflation on their business and profits and the implications for their guidance. Until recently, many commentators believed – or at least hoped – that the inflationary surge was a temporary spike, but it is now obvious that the era of low inflation and low-interest rates is a thing of the past and that high  inflation across many categories may be with us for the foreseeable future. As such, companies are now having to quantify the effect that cost inflation is having – and is likely to have – both on the demand for their goods and services and on their input prices.

What investors want to see

Understanding the complexities of the effects of inflation on input prices and the extent to which these can be offset or mitigated is an area that requires quite specific guidance. In essence, investors will be looking for information to answer these three questions:

  1. Which elements of your cost base are seeing the most significant price inflation: what has been the recent trend and what is the outlook?
  2. What does this mean in terms of your ongoing cost base, both in terms of its financial quantum now and in the near future and how much of this will be seen in your margins and therefore in your profitability? Do you believe this to be a permanent state of affairs or is there any evidence that the pressure will ease?
  3. What can your business do about these cost inflation pressures: what steps can you take to offset or mitigate them? Can you pass on some/all of these costs to your customers through price increases or do you have to absorb them? What tools do you have to reduce the impact such as: product re-design, product substitution, improved buying processes, cost-cutting or outsourcing programmes?

A summary of what we have seen 

A changing landscape: For most companies, the dramatic rise in inflation has been largely a 2022 phenomenon and they are still adapting to it, both in operational terms, but also in how they are choosing to report and commentate on it.

All companies are being impacted, but some are being more negatively impacted than others: Most companies are already seeing the impact of inflation either on demand for their products and services and/or on their input costs. In a minority of cases, companies are able to report that their business model has allowed them to entirely offset inflationary pressures, usually by repricing or from taking swift action to cut costs: in a few cases, companies have been able to report margin expansion in 2022.

Guidance and commentary on cost inflation varies hugely: there is a wide disparity in the way that different companies are currently reporting and guiding on inflation. Although most companies in our sample make some reference to the inflationary environment in which they are now operating, a surprisingly high proportion of them gave few details. Several companies noted that they were ‘mindful’ of the inflationary pressures on their business or on their customers, but others also said that it was too early to tell or hard to predict the effect that it would have on their business. By contrast, a number of companies have provided a far more detailed assessment of the effect inflation is having and is expected to have on their businesses, the financial cost of that pressure on their margins and profitability and the steps they can take to help mitigate and offset inflationary pressures.

Even if the message is not cheerful, it helps to provide detail and granularity: best practice is still emerging in this area, but instinctively the fuller and more detailed the narrative, the more useful this is likely to be for investors and analysts. If a company itself says that the ongoing effect of inflation is too early or difficult to predict, then what chance do analysts or investors have?

Remember the three questions that investors will be asking: whilst accepting that predicting the effect of inflation on future customer behaviour and demand is difficult, with regard to input pricing, remember the three questions that investors and analysts will be asking. The reality may not make for pleasant short-term reading, but the answers to these questions do need to be reflected in your forward guidance. Be clear about the nature of input costs as what might be obvious to you might not be obvious to the market: for example, who would have guessed that the price of dry ice and carbon dioxide could cost a business (Ocado) an additional £15-20m a year?

“Be clear about the nature of input costs as what might be obvious to you might not be obvious to the market”

Keep your narrative and guidance updated: while the direction of general cost inflation is now well-understood, the last few months have also been characterised by extreme volatility, particularly in certain categories. Prices of some raw materials and commodities have fluctuated wildly, often doubling or even more but also, in some cases, retreating again. Other factors, such as the recent strength of the US dollar, have also been very significant and will have a knock-on inflationary effect on the costs of raw materials that are priced in dollars. It is important to keep reminding the market of these factors, but also to update your guidance to reflect any significant changes or movements in the prices of products or services that impact your business.

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