WHAT A DIFFERENCE a month makes. After I wrote about economic recovery and my own scepticism, October saw UK consumer confidence rise to the highest level in six years. The IMF upgraded its forecast for UK GDP based on improved business and consumer confidence, and predicted that European economies will cease contracting. The Deloitte CFO Survey for the third quarter 2013 has been published, and I am fascinated by its positive views.
It reports that uncertainty is at a three-year low, and appetite to take risk onto balance sheets is at a six-year high. CFOs report an eight-year high point in pressure from institutional investors to reduce cash levels and to boost capital investment and discretionary spending. CFO optimism has risen for the fifth successive quarter, and many report an improvement in credit conditions to a level not seen in six years.
Before you get too enthusiastic, note that the survey does contain warning shots. First, CFOs do not believe the Bank of England guidance that interest rates will remain unchanged until 2016. The markets and The Times Shadow Monetary Policy Committee agree with them. Second, there are doubts about economic growth prospects for emerging markets. Third, although there is renewed confidence in the euro, there are complaints about European constraints, but EU membership is seen as beneficial. This is supported by Nissan’s view that if the UK leaves the EU, inward investment will be constrained.
Another recent report, the E&Y Global Capital Confidence Barometer, suggested that CFOs are gravitating towards low-risk growth strategies. Valuation levels and funding availability provide opportunities for a first-mover advantage strategy, but the report notes a paradox: a disconnect between confidence and M&A activity, which tended to move in harmony before the crisis.
What are the actions and priorities for FDs as we proceed through this cycle? We should focus on the capital agenda, moving from preserving our capital resources towards raising capital for growth. We should reconsider our investment appraisal techniques to determine how relevant they are. The struggle to forecast performance during the downturn will no doubt be equally difficult during an upturn, and this is another risk.
We should balance exuberance with pragmatism, avoid making hasty mistakes, and be on the alert for external shocks. The FD must ensure that the organisation has a strategy with financial metrics appropriate to a recovery phase. Although it is tempting to focus on the exciting growth projects, austerity measures may have resulted in a need to invest in basic infrastructure issues. Austerity may even have dented the morale of people in the finance teams, and not all of them will be skilled for this next phase.
The FD should ensure the investment strategy is sound and insist that the M&A strategy is revisited before valuations increase. The FD’s challenge is to capitalise on improved credit conditions to repair balance sheets and invest for growth. Some businesses may be tempted to return cash to shareholders, but I believe this tactic is for executives who have lost enthusiasm.
A budget for short-term profit is an easier one to present than the alternative of investing to transform the business model for future growth. This era may be a brave new world for some, and past experience is no guide. But as Warren Buffet said, “If past history is all that is needed … the richest people would all be librarians.”
This recovery phase will divide FDs. My own experience leads me to agree with one point raised in the E&Y report: When does risk aversion become a risk in itself? Evidence of a recovery came from E&Y itself as it increased its fee income this year by 5.8%, while Deloitte UK grew by 8% – reflecting the ‘new optimism for British businesses investing for growth’.
Last month the Secret FD attended a public meeting at a flagship university hospital NHS trust and was treated to an impressive presentation of its long-term plans to invest in infrastructure, research and expansion, and to diversify its income. The confidence level was inspiring.