ScotlandOnSunday: The record breakers: “Shell and BP together have added another £18bn to the UK’s profits total, which is entirely down to the booming oil prices.” (ShellNews.net) 13 Feb 05
ONLY six months ago John Varley joined the elite list of FTSE 100 chief executives, taking the top job at Barclays Bank. Last week he joined another exclusive gathering after becoming the latest big company boss to unveil record profits.
Lord Browne did likewise earlier in the week, when he announced that the money was gushing as never before at BP - alongside news of a £1bn jump in dividend. That followed similar milestones from his counterparts at Shell and ExxonMobil. Over the next few weeks Royal Bank of Scotland boss Sir Fred Goodwin and his HBOS counterpart James Crosby will join them in the "record profits" club, as will Lloyds TSB’s Eric Daniels and HSBC’s Stephen Green.
The corporate money machines have helped push the FTSE 100 back above the 5,000 point mark for the first time in two and a half years, fuelled by takeover speculation as private equity firms line up bids for everything from Woolworths to Virgin Radio.
The London Stock Exchange - at the centre of a takeover battle itself - has also revealed that January was its busiest ever trading month, with shares worth almost £400bn changing hands.
It would be easy to get the impression that the markets are standing on the cusp of another charge north. But while it may seem that this is beginning to look like a bull market, it is more likely to walk at the modest pace of a dairy cow.
Even the season of bumper banking profits which Varley kicked off last week will not be enough to make Gordon Brown’s sums tally in time for the general election.
"You have to be very careful not to get carried away," says Paul Niven, head of strategy at F&C Asset Management. "The thing about all these record profits is that they have been concentrated in a very small number of sectors - sectors which form a substantial portion of the FTSE. And while I don’t want to belittle what the likes of BP have achieved, crude was above $50 a barrel for much of last year.
"Our forecast for the FTSE this year was a peak of about 5,000. The year has started much stronger than we expected. There probably is more to go for, but don’t be fooled. We’re still looking at slow growth over the longer term."
The combined profits of the big five high street banks for 2004 are expected to come close to £30bn, thanks to the continued strength of consumer lending and improving business conditions. Shell and BP together have added another £18bn to the UK’s profits total, which is entirely down to the booming oil prices.
Together, the banking and oil sectors account for 38% of the blue chip index. When their shares move, the FTSE 100 moves.
In the year to date the index has gained about 3.6% - a breakneck speed by recent standards. It’s still a long way short of its all-time high of 6950 reached in December 1999, but heading in the right direction.
Investors are less worried about terrorism, more optimistic about the US and less concerned about the dollar - which is all contributing to the positive mood. But the FTSE’s rise is almost entirely attributable to this small handful of companies making giant stacks of hay while the sun shines.
The same high oil prices which have been boosting Shell and BP have been crippling other sectors of the market through higher input costs. Last week chemicals giant ICI became the latest major firm to indicate that it was going to have to push up the price of its products, such as Dulux paints, to cope with the rising costs of oil.
According to calculations from the Item club, the forecasting group which uses the same models as the Treasury, the record profits haul from the UK’s top 10 banks will bring an extra £2bn in tax revenue to the Chancellor this year. But as these profits are only being recorded by a handful of companies, Gordon Brown’s optimistic projections still look skewed.
"You have got to say that Brown is still going to struggle," says Peter Spencer, economist to the Item Club. "The increase in profits he was expecting - or rather the increase in corporation tax - was 21% this financial year.
"Barclays profits are up 20%. Along with the other top 10 banks, this is all good news for the Treasury. They’ll also make a lot more from Shell and BP and from Petroleum Revenue Tax thanks to the high oil prices.
"But to make the kind of numbers Brown is talking about, every company in the UK would need to clock up profit growth in the same league as Barclays - which simply isn’t going to happen. He’s going to do well - we forecast 15% to 16% - but not as well as he needs to."
Record profits in themselves are fairly meaningless without some sense of what the company in question plans to do with its increased wealth. With all the cash flying around the market, speculators have been buying into rumours of all kinds of mega-deals that could be about to happen.
Many market analysts believe that much of the speculation to have appeared in recent months has been generated by brokers keen to improve their dealing fees. Hedge fund traders have also been accused of creating "noise" to cover their own positions.
But deals are definitely back on the agenda, particularly among mid cap companies. This is largely why the FTSE 250 has surged ahead at 7% so far in 2005 - twice the speed of the main market. It hits a new record high on an almost daily basis.
"The big speculation this week has been about Barclays being taken over," says Frances Hudson, investment director strategy at Standard Life Investments. "That would be an enormous deal if it went through. But that’s a big if.
"Not all of these deals being spoken about are going to come to anything. Not all the deals that have actually materialised are going to go through. Woolworths was pretty quick in rejecting Apax, Glazer is now making his third attempt at Man United. But the deals are coming back.
"The UK is very well placed. While there is a lot of bid activity and speculation out there, we’re not looking at mega-mergers. It’s almost all deals priced up to £1bn, mainly in the FTSE 250 that are being spoken about.
"And it’s mostly private equity bidders, who tend not to over-pay and offer cash, which would then come back into investors’ hands, and possibly back into the market."
Cash coming back into the market is unquestionably one of the main themes behind the current buoyancy of the FTSE. Every successful private equity bid leaves fund managers across the country with money to reinvest. Another £362m was handed out on Friday, for example, when Icelandic retail group Baugur completed its takeover of Big Food Group.
But there have been large amounts of cash coming back to the market anyway. Rather than choosing to chase huge acquisitions or elaborate capital investment programmes, most of Britain’s major corporates have been giving more cash back to shareholders through increased dividends and share buybacks.
F&C’s Niven says: "Certainly over the past year the focus has been on returning cash to shareholders, which is making equities more attractive relative to other asset classes."
The average dividend yield from the FTSE 100 is currently around 3.5%. Large buyback programmes - such as those launched by BP, Shell, HBOS and Barclays last year - are adding a further 1% to the FTSE’s total yield. Special dividends, including the bribe offered to Marks & Spencer’s shareholders last year, are adding another 0.5%.
In total, therefore, the FTSE 100 is yielding about 5%. By comparison, thanks to low interest rates, a 10 year government bond is currently yielding just 4.5%. European gilts are yielding closer to 3.5%. All this is making shares more attractive to some investors. Although pension funds are still being forced into shifting out of equities into bonds to adjust their risk profile in line with new solvency criteria, the yield factor is giving further support to the FTSE.
But, Niven cautions, this is still a relative judgment. "Equities, as a standalone investment, are not that attractive. This is not March 2003 where there were countless stocks that looked seriously undervalued. If equities are the asset class of choice it’s only because they are more attractive than some of the other asset classes."
The outlook for equities is not especially rosy. Economic growth is slowing and, globally speaking, interest rates are likely to rise. Reaching the 5,000 point mark could also be a temptation for many investors to begin selling shares again, cashing in some of the gains they have made this year.
But it is difficult to find any fund managers who believe that the UK market is not in reasonable shape. More record profits are on their way. While that may not be the cause for celebration it initially appears to be, it seems a cause for cautious optimism.