Squeeze on profits could force firms to cut dividends

Firms may have to cut shareholder dividends in order to finance the investment needed to maintain profits in the face of falling margins, the Government's statisticians warned yesterday.

Firms may have to cut shareholder dividends in order to finance the investment needed to maintain profits in the face of falling margins, the Government's statisticians warned yesterday.

Rates of return for businesses will be hammered even further this year as businesses find themselves trapped between falling prices and a rising bill for raw materials, they warned. The Office for National Statistics said it believed fierce levels of competition in the UK would intensify and that profitability would remain weak.

The report was produced to explain the plunge in businesses' profitability in 1999 to its lowest rate for five years, which the ONS reported last month.

In its monthly Economic Trends magazine, ONS statistician Richard Walton said firms would either be forced to cut the dividend to free up cash for investment or to start passing on rising costs to consumers in the form of higher prices at the risk of losing orders. "It is difficult, therefore, to see how profitability can improve further without having an impact on labour costs and hence how the borrowing position of the UK corporate sector is likely to improve in the near future," he said.

Although UK firms were the most profitable in the world in 1998, the following year saw a huge squeeze on margins as raw-material prices, especially oil, surged, and high street competition drove down prices.

The biggest fall was in manufacturing where rates of return tumbled from 10.8 per cent to 7.1 per cent, the lowest figure since 1993. Services companies' profitability fell by 0.1 per cent to 15.3 per cent, a two-year low.

"Costs increases [in the second half of 1999 and the first half of 2000] were absorbed by margins, as manufacturers were unable to pass on the increase in costs to prices," Mr Walton said. He also highlighted an investment drought, as firms responded to the squeeze by cutting back on spending.

Firms sanctioned increases in investment between 1995 and 1998 by the upward trend in share prices and profits. But firms put the brakes on in 1999 as profits started to fall sharply in the second quarter of 1998. "Some investment programmes were halted, in expectation that profits ... would fall," he said.

Meanwhile, the corporate sector's financial health deteriorated as firms' deficits surged to their highest level as a proportion of GDP since 1990. The money raised may have gone towards what the ONS said was an "unusual" rebound in dividend payments in 1999. "Internal funds were supplemented by record borrowing from the capital markets," he said.

The Confederation of British Industry said the analysis confirmed its fears that business investment was falling to dangerously low levels. Sudhir Junankar, a senior economist at the CBI, said its latest survey of manufacturers showed inadequate rates of return had risen to record levels as a constraint on investment.

"It shows the sharp squeeze on manufacturers' profits in 1999 and that is a clear concern." He added he did not agree with the ONS claim that firms would be able to raiseprices. "Something that would help would be for the pound to come off against the euro. It is clearly too high."