Buchler Phillips Quarterly Bulletin No. 11

For Harry, England and St George!

More than 50 years after England’s finest hour in football when it won the World Cup, our expectations of the national team have headed as far downwards as the fortunes of the country’s industrial base since 1966. England has failed to qualify for three FIFA World Cups since then, peaking at fourth place in 1990 and coming 26th in Brazil four years ago.

Too depressed to read on? Don’t be! Beyond perennial favourites Brazil, Germany, France and Spain - and notwithstanding our dismal performance in 2014 - bookies have placed England as seventh seed (odds 16/1) from a field of 32 as the tournament kicks off this month. Realistically, there is no great science to making such prices after the first five or six, except that England knows what to do, has done it before and there are always surprises. 

Manager Gareth Southgate has little to lose. He is taking an approach that many CEOs in business might find refreshing in these straitened times: taking risks and breaking from the norm to achieve a different and better result. Southgate’s modus operandi is understated, low key and modest, with no room for a ‘star culture’. He has one exceptional striker and captain, Tottenham’s Harry Kane, but has omitted other big names to field the youngest squad of all playing in Russia this summer.  A performance from this team in line with its number seven ranking would be no disgrace and might provide a platform to build on. Germany’s winning football managers have always favoured playing the long game and growing young talent, promoting the value of an effective, attacking team over stars and talisman players.

In team sports or business, long term planning is the difference between standing still and moving forward. Like the best CEOs focused on sustainable growth, if Southgate has really set himself a clear and ambitious target, he must stick to it and gear everything along the way towards his ultimate goal. By not losing sight of the big picture, he might surprise us in Russia and keep his job to take England to the next level.

Factories still firing on most cylinders

In 1966 there were almost 9 million people working in UK manufacturing. Now there are just 2.6 million. Manufacturing’s share of the economy is around 10% today, half what it was in 1990. This year has seen a marked further contraction, with April’s 1.4% fall in output - the third consecutive monthly decline - representing the sector’s biggest fall in production in more than five years. Poor weather was to blame in March, as factories were slowed by blizzards brought in by the Beast from the East, but the problem is much wider.

UK industrial production overall has been slowing since late 2017, squeezed by a stronger pound in recent months and lower European demand. Analysts have said that UK manufacturers have wasted the opportunity presented by the post-Brexit vote weaker pound to sell more overseas. This may be true, but the industry is no longer about merely turning raw materials into physical products. Increasingly, manufacturers derive revenues from other activities which are really services, for example specialist engineering, retooling used parts or even some forms of equipment leasing. The value chain is increasingly complex and manufacturers are adapting, some quicker than others. In addition, technology in production - robotics, computer design and new materials - require fewer jobs, meaning new forms of training for different skills and a need for companies, the education sector and government to work together delivering them. Encouragingly, almost 75% of R&D spend in the UK last year was from manufacturers. Optimists might say this is an area in a period of major realignment. Hopefully, rumours of its death are greatly exaggerated.

Deal or no deal

Those fearing the worst from the post-Brexit trade scenario latch on to UK manufacturing as an early casualty. Paul Drechsler, the outgoing President of the Confederation of British Industry, warns that parts of the sector risk becoming extinct in the absence of “real frictionless trade” after leaving the EU. He cites the 800,000 people employee by the car industry as particularly vulnerable, because of its ‘just in time’ production methods.

The balance of UK CEOs in big business remains committed to staying in a customs union with a single set of tariffs for goods imported from outside the EU, while trade is tariff-free trade within it. The motor and aerospace industries in Europe are good examples of ‘ecosystems’ where components come from many different countries before being assembled in the UK, Spain, Germany or elsewhere. MPs have rejected a Lords amendment on maintaining access to the single market through the European Economic Area (EEA) - the ‘Norway model’.  While It seems inconceivable that a trade deal will not be cemented with the EU in the next few months, reverting to World Trade Organisation rules between trading partners with no free trade agreements could reduce the UK’s trade with the EU by more than between a third and 50% over ten years, economic forecasts predict.

The Department for Exiting the EU promises that a comprehensive White Paper on business will be delivered during July. It says it has completed detailed reports on 14 sectors. In the meantime, the effect of the lack of Brexit clarity on corporate investment, from the FTSE100 to SMEs, remains extremely concerning.

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Clearly ignoring the great strides made on this side of the Channel during the early industrial revolution, Napoleon famously called Britain a nation of shopkeepers. Sadly, not very good ones these days, it might be said, looking at the present carnage on the high street. Recent weeks have seen Poundworld in administration, as well as Toys R Us and Maplin.  House of Fraser, Mothercare and Carpetright are attempting to restructure, while it seems credit insurers are withdrawing support from large chunks of the retail sector. It is surely the worst year for many store chains since the financial crisis.

It is too easy to blame online retailing. On the demand side, consumer spending in the aftermath of the 2008 crisis was artificially boosted by a combination of lower mortgage payments from slashed interest rates, the PPI payout bonanza and a feelgood factor from modest real wage growth. While the fair wind behind spending has been slowing, consumers have been switching from shopping to other ‘experiences’ such as travel and eating out. On the supply side, there are simply too many stores in many retailers’ estates.

UK retail sales rose 1.3% in May compared with April with growth across all main sectors, according to the Office for National Statistics. That was comfortably ahead of analysts’ forecasts of 0.5%. Compared with a year earlier, sales volumes were up 3.9% – the biggest rise in more than a year, thanks to a combination of sunshine and the royal wedding. The World Cup could extend the growth into June and July, despite underlying challenges in the high street. Storeowners might take some comfort from the 2018 Retail Sector Report by researchers I-AM. Its survey of 2,000 18-35 year olds shows 74% of millennials still prefer stores to online shopping, with half saying the most loved element of the in-store experience is touching and trying things out.

Economic Outlook

Few would deny that the UK economy is looking weaker than expected. The Bank of England was anticipating a Q2 rebound, following a first quarter blighted by late snow. Now, forecasts of further modest base rate increases from the end of the summer may be pushed back. Building output in April rose 0.5%, well short of the strong bounce expected.  The National Institute of Economic and Social Research on Monday estimates the economy grew just 0.2% in the three months to May, with recent purchasing-manager surveys unsurprisingly showing Brexit fears weighing on new orders across the economy last month.

Jobs data, however, seem to defy economic gravity. In the three months to April, the UK workforce increased by 146,000 on the quarter to January. At the same time, tightness in the labour market means employers are fighting hard for new recruits, driving up wages. Real pay is increasing, albeit modestly, with the pace slowing from 2.8% to 2.5% in the three months to April. UK inflation (CPI) unexpectedly stayed at a one-year low of 2.4% in May. Apparently some areas of food and cheaper consumer electronics helped to offset the rising price of petrol, which  grew by 4.6 pence a litre between April and May to 125.3 pence – the highest level since October 2014.

Consensus forecasts in June 2018 expect UK GDP growth this year to slow to 1.4% from 1.8%. As the UK leaves the EU next year, this could slip further to 1.3%.

 

Buchler Phillips is a corporate recovery and restructuring firm, dealing also with complex turnaround and fraud assignments in a wide variety of sectors. Please view our website for more information.

This bulletin is published for the purposes of general information only and does not constitute advice. Any action taken by readers upon the information above is entirely at their own risk