The bottom line:
Fundamentally, whilst there are reasons to be optimistic as we move through the early months in 2023, businesses which are in challenged sectors, particularly if they are highly leveraged, will continue to find things difficult for the foreseeable future.
2022 was a challenging year for many UK companies. Businesses which had just about hung on during the pandemic and were hoping for better days had surely not predicted sky high raw material costs, supply chain issues, labour shortages, rapid increases in interest rates and falling consumer demand as cost-of-living pressures began to bite. That’s not to mention the huge uncertainty that was created through the political turmoil that we all endured through the second half of the year.
In my job as a covenant specialist advising on companies which support defined benefit pension schemes, I get to see the impact of these pressures first hand. For me, 2022 was a year of two halves with my day-to-day work switching from an initial focus on M&A activity (as investors put the cash they had been sitting on across the Covid period to good effect), to fire fighting in more distressed situations.
It is interesting to compare my experience on the ground with recent insolvency data published by the ONS, which shows an uptick of business failures from Spring 2021 as many of the government-backed Covid protections began to ease off. Since then insolvency rates have become notably higher when compared to pre-pandemic levels.
Registered company insolvencies in England and Wales (not seasonally adjusted)
Sources: Insolvency Service; Companies House.
I was asked to write this article in January. This was mid-way through advising a group of trustees on the state of a severely distressed employer, which did make me think at the time that there would inevitably be a pessimistic slant when I came to put pen to paper.
However, as we move into the Spring, some positive indicators are beginning to emerge regarding the outlook for the economy. For example:
- The UK surprisingly managed to avoid a recession in 2022, with slight growth achieved across Q4.
- There was an unexpected fiscal surplus of around £30 billion recorded for January.
- Headline inflation declined to 10.1% pa in January, down from its 41-year peak of 11.1% pa in October. Whilst a rate of more than 10% is nothing to shout about, the direction of travel is encouraging.
- There are also reports that UK consumer confidence is beginning to rebound as households are showing signs of being resilient despite the cost-of-living crisis.
- Admittedly, such confidence is still severely depressed compared to historical levels, but perhaps we have now reached the bottom of the curve.
Coming back to my day job, the businesses I have been working with which have been challenged across the last six months or so are generally in sectors which will not surprise you, mainly being manufacturing, construction and retail. Companies where discretionary spend is a big part of the business model have also been struggling, as well as highly leveraged organisations which have not had room to manoeuvre as rates have gone up. Taking all of the issues that are impacting the UK economy right now, it is even clearer to see the sectors which could most do with a turnaround in the market environment sooner rather than later.
LCP sector exposure mapper
Source: LCP analysis
However, in line with the encouraging economic data that is coming to light as we move through 2023, new information is also beginning to be published which shows further encouraging trends across sectors. For example, Lloyds Banking Group’s UK Sector Tracker published in mid-February suggested that all of the UK sectors it monitors were forecasting output growth across 2023 despite the exposures they may be facing, driven by expectations of weaker inflation over the next 12 months.
How quickly the UK recovers across 2023 and beyond appears to be influenced by a number of factors, including what actually happens with inflation, the outcome of the Bank of England’s decisions on interest rates and the continuing effect of the war in Ukraine across the globe.
But a really important factor in future prospects is the legacy of the Brexit vote in 2016 and what has occurred since. Labour shortages are still an issue for lots of the clients that I advise and red tape is continuing to see cross border trade hampered and UK exporters being less competitive than they would like to be. Recent forecasts published by the IMF also made for dire reading when comparing the UK to other developed economies, but make a lot of intuitive sense with the UK being the only country of those assessed to voluntarily decide to make trading conditions more difficult for itself.
IMF 2023 real GDP % growth forecasts for G7
Source: LCP analysis
So in summary, whilst there is cause for optimism, the UK economy is certainly not out of the woods, times will remain challenging for vulnerable businesses in exposed sectors and, if I have learnt anything across the last three years since the pandemic hit, it is to expect the unexpected. What do I expect to see in my day job across 2023? Well, the liquidity pressures impacting on some of my clients will not go away anytime soon and I’m expecting further work on distressed cases. However, I am also expecting deals to begin to come back as business confidence starts to improve and the warmer weather starts to arrive. Those business which have been adopting a wait and see approach on capital investment programmes may think that time is right to move forward with their plans. I also see ESG factors becoming much more central to our longer-term assessment of the financial health of companies, as consumers attitudes change.