A Mixed Performance in Q2 of 2006

The Q2 2006 survey provides mixed results on the financial health of UK corporates, with evidence of a modest improvement in free cash flow balanced out by a further depression in profits growth.

Taking the survey results as a whole and bearing in mind anecdotal evidence from respondents, financial conditions still look tight, a conclusion supported by the latest data on the incidence of payment delays from UK customers, which indicated the sharpest increase in over four years.

Despite the positive effects on profits of a buoyant global economy, rising costs have continued to depress profits growth in Q2 2006. Our research has shown that profits growth was again sluggish, depressed by high raw material prices and price discounting.

FREE CASH FLOW

Annual growth of free cash flow picked up, however, to a solid pace that was above the long-run series average. Although still only modest in real terms, this growth was significant in being the strongest since Q3 2004. Solid growth of cash flow at service providers and manufacturers underpinned the overall improvement.

Growth of cash flow was also recorded by distribution firms, albeit at the weakest rate since Q3 2003, while construction companies saw a return to weak expansion of cash flow following a marked deterioration in Q1.

UK corporates were also optimistic that their cash position would improve further over the course of the coming year, with growth in cash flow of 5.1% predicted on average.

UK company profits improved for the third consecutive quarter in Q2, but failed to break the cycle of negligible growth recorded over that period, while the impressive performance of the global and, importantly for UK firms, euro area economies again had a strong positive influence on profits.

This was countered by the squeeze on margins from high raw material costs and the discounting of output prices.

PAYMENT DELAYS

Difficult client cash conditions continued to be blamed for an increasing incidence of payment delays over the quarter.

The rate of increase of payment delays from UK customers remained particularly sharp, picking up to the steepest in four-and-a-half years in Q2. An increase in late payments from overseas customers was also reported, but at a much slower rate than that seen for domestic customers.

Companies reported that payments from UK customers were, on average, 21 days late and payments from overseas customers 23 days late. Overseas payment delays were most common from clients in Spain.

Those sectors performing the best are those that have most successfully harnessed the benefits of a buoyant global economic backdrop, using the strengthening of demand to recover their pricing power and offset surging costs.

In this regard, the service sector stands out, posting strong growth of both cash flow and profits over the quarter and experiencing the weakest growth of payment delays from their clients.

At the other end of the spectrum, construction firms continue to suffer, seeing profits squeezed again in the face of rising costs and sluggish recent housing activity.