A Surprisingly Profitable Recession

A 50% rise in just six months looks like a stock market bubble. And, given that it is so hard to see how the poor old consumer will prosper in the age of austerity, it feels like a bubble too. Yet there are still companies producing figures to support the view that not all valuations are being driven by the wave of money looking to escape the miserable returns available on cash and government bonds.

Take Compass Group. Like-for-like revenue will contract by about 2.5% in the six months to September, the caterer said today. Some £300m of activity in areas such as corporate hospitality at sporting events and smart dinners has disappeared.

Yet the effect is barely noticeable at the bottom line. Earnings per share should be up 14% for the full year.

Naturally, Compass has a factor in its favor. In the jargon, it has a flexible cost base – so, if the top brass at State-Aid Bank plc don't want to be seen quaffing too much champagne, Compass doesn't need to hire temporary staff to serve the bubbly. An opportunity for profit is missed, but little damage is done.

But there are other factors at work. The arrival of recession was hardly a secret, so companies such as Compass had time to plan.

Some of its prescriptions like "menu planning" (trading choice for quality) are really examples of good housekeeping, but the result is a strong increase in profit margins – not what you would expect at a time of shrinking demand.

This pleasant game cannot continue indefinitely since efficiency drives have limits. But cases such as Compass help explain why the much-heralded collapse in corporate profits has not fully materialised.

A related phenomenon can be seen in the holiday industry, where operators including TUI Travel have coped with falling demand by selling fewer holidays at higher prices.

But is the pain simply being delayed? At Compass, chief executive Richard Cousins can be confident that there is more juice to be squeezed from margins. In general, however, there is no real substitute for strong orders since profit margins never go to the moon, whatever directors like to believe.

That is why stockmarket bears are probably right to argue weak consumer demand, impeded by higher taxes, will prevail in the end.

But it's a matter of timing, and the resilience in profits in some quarters of the corporate UK landscape has been one of the surprise stories of 2009. Bad news for those investors who missed it.

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Ten shares for a penny: what a bargain. Well, no, it's not, as HSBC discovered yesterday when it made an unwanted entry into photography. It is taking a 47% stake in Jessops and writing off £34m of a £54m loan. Those shares, now worth 0.1p, traded at 155p five years ago.

What, you may ask, was a conservative bank like HSBC doing lending £54m to a smallish high street operator in a market where the internet was driving down the profit margins of camera retailers? Didn't it have better lending prospects in, say, the far east?

Jessops is another tale of those mad pre-credit crisis days when any company with a flimsy "growth" story could get a huge loan. The tale told by Jessops was that the arrival of digital photography had transformed its outlook. It had – but not for the better. By the time Jessops woke up to the opportunities, others had stolen the market. Most point-and-shoot cameras are now sold online.

The debt-for-equity swap, plus debt write-down, gives Jessops a chance to return to what it was; a middle-of-the-road retailer with 200-odd shops serving local communities.

In the context of HSBC, £34m is nothing. Nor, it should be said, was the bank the most enthusiastic lender in the wild days. Have we seen the last of the write-downs from elsewhere? Obviously not. But have adequate provisions been made? It is impossible to tell.

Just say no

Never buy protection from the person who is selling the product you wish to insure. It rarely offers value for money.

This principle should be drummed into children at primary school. It would help them in their future encounters with the financial services industry, where the ruse of flogging expensive adds-on to a "cheap" loan often becomes an obsession.

The Financial Services Authority is again revisiting the market for payment protection insurance, or cover against illness or unemployment. It suspects that mis-selling went wider than the banks have admitted; it is probably right. This is an area where the FSA could usefully deploy its educational budget. The message: just say no.