Which companies can grow their profits in 2012?
We may be facing a low growth economy, but there are still companies increasing their profits, just not always where you expect to find them, writes Stephen Message, manager of the Old Mutual Equity Income fund.
In an environment of low economic growth and subdued levels of consumer confidence, as we are currently witnessing in the UK, the task of growing profits for many businesses becomes increasingly challenging.
The recent profit warning from Tesco is a good example. In our view, it indicates the high level of competition in the food retail sector. Whilst many would consider this sector to be fairly defensive in nature given that demand for food does not fluctuate materially, competition is fierce and retailers have to work hard to win their share of consumer spending through a range of promotions and offers.
Unfortunately, cutting prices to win business often means lower profits, and in Tesco’s case, a tougher than expected festive sales period ultimately wiped almost £5bn off the company’s value.
The food retail industry has been successful in growing profits over the past decade through expansion of their selling space, improvement in supply chain efficiencies, diversification into non-food and also previously through a more buoyant consumer.
Given that it feels we are at a saturation point in terms of selling space (Tesco highlighted it will build fewer out of town megastores), and a more price conscious shopper, it seem likely that it will be more difficult for the industry to enjoy the rates of growth that it has in the past and we currently have little exposure to this area in our portfolio.
In a mature market with acommoditised product offering you can often only charge as much as the cheapest competitor. Another industry cutting prices at the moment is the domestic energy sector.
EDF Energy recently announced it would be reducing its gas bills to its customers by 5%. In order to hold on to their customers we imagine the other energy suppliers will follow suit, which could have implications for the profits at UK listed energy suppliers SSE and Centrica.
The dynamic in this industry is similar to that in food retail; a sector dominated by a few large players where demand for the end-product is fairly robust. However the pricing environment is challenging putting pressure on industry profits. Therefore we also have little exposure to the utility sector.
While we think life will be tough for some of the businesses operating in the food and energy retail space, we are still able to find a number of interesting investment opportunities operating in the UK that can continue to deliver healthy levels of profit growth.