May 19, 2022

A Tight U.K. Labour Market – Impact on Margins?

by Tajinder Dhillon.

Fed Chairman Jerome Powell has alluded to a ‘hot’ labour market in the U.S., as the current number of job openings far exceeds the total number of unemployed – 4.5 million to be exact.  In other words, a tight labour market occurs when job openings (demand) > total unemployed (supply).

Moving across the Atlantic, the U.K. finds itself in the same position for the first time ever.  The latest data from the Office of National Statistics shows total job openings at 1,295k, an all-time high.  Conversely, the number of individuals who are unemployed dropped to an all-time low of 1,257k.

Comparing the two, there are currently 31k more job openings vs. the number of people who are unemployed, leading to a positive spread for the first time on record as shown in Exhibit 1.

Exhibit 1 – U.K. Labour Market

  • Product Insight: Datastream mnemonics used in the chart above are “UKCVAC..O” and “UKMGSC..O”

The tight labour market has led to a surge in nominal wage growth, as total wage growth (including bonuses) increased 7.0% and sits in the 98th percentile (Exhibit 2).  Wage growth excluding bonuses rose to 4.2% and sits in the 85th percentile when looking back over 20 years.

However, when taking inflation into consideration, real wage growth is currently negative as U.K. CPI reached a 40-year high of 9.0% on April 18th.  Core CPI came in at 6.2% which is also at a 30-year high.

Exhibit 2 – U.K. Wage Growth

  • Product Insight: Datastream mnemonic used in the chart above is “UKKAC3..Q”

Have higher wages impacted margins?

Looking at the constituents of the FTSE 350, we calculate the forward 12-month EBIT margin using Refinitiv Datastream to assess if analysts have adjusted for a higher labour cost environment.  Over the last year, the aggregate EBIT margin has remained stable, slightly improving from 14.9% to 15.9%.  Exhibit 3 displays the current forward EBIT margin.

At a sector level, Energy has seen the largest improvement over the last year, rising 4.5 ppts (8.1% –> 12.6%), followed by Technology (+2.8 ppts, 13.6% –> 16.4%), and Consumer Discretionary (+2.0 ppts, 8.8% –> 10.8%).  Basic Materials has seen its EBIT margin decline by 3.6 ppts (21.5% –> 17.9%).

Exhibit 3 – Forward 12m EBIT Margin

U.K. inflation swaps suggest inflation is here to stay.  The 1-year inflation swap currently reads at 9.2%, far greater than its European and U.S. counterparts at 6.7% and 5.2% respectively. Furthermore, the U.K. 5-year inflation swap sits at 5.2%, far greater than its 2% target.

If higher wage growth and inflation remains higher for longer, we may see more aggressive downward revisions in analyst estimates for companies who are unable to either pass higher costs to consumers or manage internal costs more efficiently.

Which sectors may see its margin at risk?

To determine which sectors may suffer from weaker margins due to rising labour costs, we use Refinitiv Workspace to compare labour costs to both operating income and total revenue.  Exhibit 4 highlights aggregated labour exposure by aggregating individual constituents of the FTSE 350 index using the most recent reported fiscal year for each constituent.

At an index level, the average labour expense as a percentage of total revenue is 12.0% using a cap-weighted approach.  As a percentage of total operating income, this rises to 106.7%.  The median values are 11.1% and 31.3% respectively.

At a sector level, Information Technology has the highest proportion of labour expense relative to total revenue (28.8%), followed by Health Care (28.0%) and Industrials (25.3%).

Consumer Discretionary has the highest proportion of labour expense relative to EBIT (870.4%), followed by Industrials (546.9%), and Information Technology (272.7%).

Exhibit 4 – Labour Exposure for FTSE 350 Index

Refinitiv Workspace is a complete solution for research and analytics. It places the most comprehensive market information, news, analytics and trading tools available into a desktop.

Refinitiv DatastreamFinancial time series database which allows you to identify and examine trends, generate and test ideas and develop viewpoints on the market.

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