Britain's Blue Chip Blues
It was a blinding flurry of activity. In rapid succession yesterday, analysts following British Airways, Vodafone and ITV told investors what they already knew. It seems that, faced with a looming recession, increased job insecurity and sky-rocketing prices for basics such as food and fuel, people are going to use the services these companies proffer less. The trio will, as a result, have a harder time making money.
The downgrades meted out yesterday to these most visible members of the UK's corporate community are part of a time-honoured pattern. Analysts, economists and, yes, journalists, professionals paid to predict what's around the corner or at least give a reasonable appraisal of the risks that could lay us low, usually fail quite spectacularly at the task. Since the market's peak last summer, just before the credit crisis bit and sent Northern Rock tumbling toward oblivion, the FTSE 100 has shed 15 per cent. Each week seems to bring another batch of bad news: companies running aground, bleak economic figures, failed deals ending in lawsuits and recriminations.
Yet it wasn't until yesterday that Goldman Sachs slashed its target price for BA from 330p to 200p. The Terminal Five debacle was, of course, a factor. But the main reasons for Goldman's new-found pessimism were by no means novel. The soaring price of jet fuel and the carrier's heavy dependence on a rapidly slowing America have been weighing on investors' minds for months, leading them to lop off more than half of BA's market value in the last year.
It is fair to say that investors in the airline, and almost every other European airline stock for that matter, had long since formed their own opinions about the outlook for the carrier. Its already-beaten-down shares barely reacted to the Goldman note -- ending the day down 2 per cent at 234.25p -- lending yesterday's action the air of a warning of an event long-since passed. "One would like it to be different but as a general rule, forecasts tend to lag bad news rather than to lead it," said Kevin Gardiner, equity strategist at HSBC. "Global market analysts have yet to cut their earnings to levels that look plausible."
Indeed, investors seem to be well ahead of the analysts they so generously remunerate to tell them where to put their money. According to Mr Gardiner's research, investors have already priced in a 40 per cent drop in returns on equity for "a sustained period", meaning for the rest of this year and well beyond. In other words, they expect returns to come in at around 11 or 12 per cent, rather than the record high teens of the most recent bull-run and the mid-teen average return over the last decade. "The market has already priced in material declines from current levels, not just slower rates of growth. The only issue is whether [future downgrades] will be above or below what the market is pricing in."
The lag-time has been exacerbated by of the nature of the crisis, beginning as it did in the murky depths of the global credit market. Bernd Meyer, chief equity strategist at Deutsche Bank, said: "It's even worse this time around because the whole problem started in the financial markets, not in the real economy. It's only coming through now to the consumer." Things will get much worse, he predicted. "Analysts' estimates, on average, are far too high still. They will have to come down. There will be more downgrades," he said.
As the crisis started to spread into the farthest reaches of the economy, investors aggressively reassessed companies, sector by sector. Banks have been hammered, as have the housebuilders -- Panmure Gordon slashed Barratt Developments last week -- and construction companies. Airlines have seen their valuations plummet, while consumer-facing companies have already begun battening down the hatches. Kingfisher, owner of the DIY chain B&Q, cut its dividend last week as part of a far-reaching austerity scheme to see it through the downturn.
Save for the occasional voice in the wilderness, City analysts have been late to the party, issuing screaming "Sell" notes when investors had already done so. Consider ITV. The market has long been wise to the "deteriorating" advertising market and scheduling challenges facing the "Coronation Street" broadcaster -- its market value has accordingly halved in the past 12 months. Yet it wasn't until yesterday that UBS, the broadcaster's house broker, slashed its price target for the company by 14 per cent to 60p. "Over the past year, we have been negative on UK media owners given structural pressures and the risk of a consumer slowdown. This risk is fast becoming a reality," the note read.
Part of this can be explained by the optimism that is endemic to chief executives. "For analysts, it's a question of who should I believe?" said Mr Meyer. "The economists who are predicting a recession, or the companies who have just reported nice numbers and reiterated their forecasts?"
Just how bad it will get depends on whether the changes now in motion are part of a typical cycle, or if more fundamental structural shifts are occurring. There is cert-ainly a long way to fall. Corporate profitability across Europe is at an all-time high. This is due to three factors: low wage growth due to globalisation and productivity gains from the internet and mobile communications; disinflationary forces such as the flood of cheap Chinese goods and the availability of cheap debt financing; a long, steady drop in corporate tax across Europe, from about 35 per cent fifteen years ago to about 25 per cent today.
Mr Meyer is sticking to the prediction that what we are now experiencing is a standard cyclical adjustment. But if fundamental changes are in train, there is still has a long way to fall.
Making such predictions is, of course, as much art as science. As if the point needed proving, a note from Citigroup. On the same day that Goldman slashed its price for the beleaguered BA to just 200p, Andrew Light, the Citi-group analyst, took a strikingly different view. He reiterated his "Buy" recommendation on the stock yesterday, with a target price of 400p.