BRITAIN HAS BEEN MIRED in its longest peacetime recession since the Great Depression. The eurozone sovereign debt crisis rumbles on with a clear solution yet to emerge; while the banking sector across Europe continues to face headwinds. Throw in some of the worst weather on record – which has further depressed the consumer economy – and the last 12 months have felt deeply gloomy.
There are early signs that the economy began to pick up over the last six months. The results of our latest CFO Survey are surprisingly strong and in marked contrast to the general mood of gloom in the UK economy. Business confidence has risen for the third consecutive quarter and is now above its five-year average.
However, this shift in sentiment hasn’t yet propelled CFOs towards more expansionary policies, such as capex and mergers and acquisition activity. For British companies, that have spent the four years since the financial crisis in a hiatus of uncertainty, the temptation is to do nothing until the UK economy definitively improves and the eurozone’s problems are resolved one way or another.
Yet large British companies both listed and private, are facing challenges they need to address – as well as opportunities they should grasp – right now. We’ve prepared a seven-point checklist of what CFOs should be thinking about this summer.
Staying liquid: Scaling the refinancing wall
A formidable wall of debt maturities will hit the markets in the period leading up to 2015. With European banks under orders to bolster their own capital buffers, debt from traditional funders remains challenging for a large number of corporates. There is an increasing pool of alternative lenders serving both large and mid/small corporates. The high yield market has re-opened in 2013 after a period of volatility over the past two years.
Companies should act now to ensure they have access to cash, especially in light of the favourable liquidity markets and funds chasing yield, and this could all come to an abrupt ending if there was a market shock. If I were a CFO, the thing I would have on my radar would be look carefully at my debt maturity profiles and ensuring access to facilities over the next five to seven years. Previously we all operated at the limits of what was possible. With the economy still muted, companies remain conservative. Unlike in the boom years, covenant flexibility is now often more important than headline interest rates. We have come a full 180 degrees. Borrowers want covenant flexibility, in the main because they don’t want the publicity of a breach. Borrowers are also prepared to pay a high coupon rate to have certainty of access to facilities.
Cash piles: Making them work
While some companies are facing a liquidity crunch, others have been conserving cash since the financial crisis. The Deloitte 2012 UK Working Capital Performance Study revealed that excess working capital held by UK plc has risen to £64bn. As a consequence, the collective balance sheet of corporate Britain is in its best shape for decades and companies must decide whether to spend that cash on acquisitions and investment, return it to shareholders or save it for a rainy day.
In the face of uncertainty, many are choosing to save. CFOs need to consider where to put that money to ensure that they get a good interest rate for balances. Also, with some of Europe’s banks still financially unstable, they need to ensure money is left in a solid financial institution, or spread between a number of banks.
Zombies: Bringing them back to life
One of UK plc’s biggest hangovers from the credit crunch is the emergence of so-called “Zombie Companies.” Zombies are operationally sound businesses, which were acquired or refinanced in the boom times and saddled with a debt burden that can never be repaid in full because it is so great. A major problem such companies face is in retaining and incentivising top talent. The solution for Zombies is for their loans to be allowed to work their way out of the financial system over time. Over the next three years or so, financial institutions will be obliged to de-leverage their balance sheets.
Consequently, we have over the past 18 months seen a number of loan portfolios come up for sale which may be a relief to Zombie companies. The new lenders will have a different outlook on getting an appropriate return on the loans and so will seek to restructure the debt and equity, which will also act as a catalyst to re-base incentive structures for management teams. While having a new lender or owner may be a great relief to management teams of Zombie companies, the new alternative lenders have a different perspective on returns for par lenders and, as such, management needs to understand how to deal with a different type of stakeholder.
Planning for uncertainty: Eurozone
Planning for uncertainties within the macro environment should be a core consideration within any forecasting process. For example, the macro-economic consequences of the global debt bubble are still raging in Europe in the form of the continent’s sovereign debt crisis. While the eurozone is moving slowly and painfully in the direction of a resolution, huge economic and political downside risks remain. Businesses should continue to prepare for all eventualities.
The number one question issue for my clients remains the preparedness and resilience of their business to negative developments in the Euro area. We support our clients in quantifying the risk, and then we test their business against possible scenarios. Whilst the process and situation is clearly unique for any given company, there are some common themes and questions which should be addressed. First, separating the time horizon to look at shorter-term risk mitigation activities versus longer-term, strategic considerations – it is essential to meet short-term response objectives without closing down future strategic options. Second, ensuring there is a robust and considered assessment of both the downside risks to be managed and also, crucially, a view on the upside opportunities which may present themselves as the eurozone marketplace re-balances itself (e.g. pricing, market share, acquisition opportunities). Finally, it is important to develop a pragmatic and achievable approach where management time and company resources are effectively allocated to support the company’s response.
Good housekeeping: Sweeping away old problems
For CFOs who do not have the cash – or desire – to expand, a recession provides opportunities to control costs; make economies of scale and position their companies for growth. This is an opportunity to reconsider older acquisitions and how they were integrated. Often organisations would run integration programmes that come to an end when people believe it has been fully integrated. However, when looked at, particularly with the benefit of hindsight, it is often clear that more could be done and that there will be a better understanding of the acquired organisation. It is understandable that some of the more complex decisions were left unanswered due to politics, people issues or a lack of resource. However, regardless of the economic environment, no stone should be left unturned and thus those areas should be revisited.
Opportunism: Positioning for growth and acquisitions
After four years of cost-cutting, cash-rich companies should now be positioning themselves for an upturn as well as considering strategic acquisitions that can deliver economies of scale in a low-growth environment. Business has accepted the new economic reality is here to stay. Despite a feeling of optimism, this new reality will be characterised by below average growth conditions, with shorter and more volatile economic cycles. The longer slow growth persists, the higher the pressure on corporate profits. So ‘wait and watch’ is not really an option for the corporate sector and they need to adapt to volatility as the new ‘normal’.
Even though caution seems to be the prevailing market sentiment, the conditions for deal making remain fertile. Corporate sector are sitting on historic amounts of cash reserves, have deleveraged significantly, there is access to cheap credit for the stronger companies and equity markets are staging a recovery.
In conditions where even modest organic growth is hard to achieve, CFOs and corporate leaders need to consider inorganic growth opportunities, otherwise they risk squandering their hard won gains.
Global strategy: Looking beyond Europe
New Deloitte research shows that UK big business (with annual revenue in excess of £1bn) is looking overseas for growth. The survey shows that 75% of large UK companies expect to be either a global leader (i.e. within the top three in their industry worldwide) or an international company (having over 50% revenues coming from foreign markets) within the next five to ten years.
For companies approaching emerging markets, the challenges can be daunting. Some markets are technically difficult to enter, due to indigenisation laws affecting their talent strategies (African and some Middle Eastern countries in particular), whereas some countries place restrictions on foreign investors (India for example). Ignorance of the local market and business customs are also a challenge, especially if the business language is not English. Of course, these challenges can be mitigated if a company chooses to enter the market through a joint venture or acquisition, and companies can always dip their toe into a new market by trading or offering franchises first. This model has worked well for many international retailers in Russia and the CIS, for example.
In a dynamic, globalised economy, simply staying still is just no longer an option. CFOs must stay ahead of the curve, not only addressing any problems before they occur, but they must take advantage of the current business environment. These seven areas should be priority for CFOs, while maintaining their sound approach to making big business decisions.
Marcus Boyle is head of Deloitte’s finance transformation practice
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