The Deloitte CFO Survey: 2017 Q1

Q1 2017

The Deloitte CFO Survey Brexit shock eases The first quarter survey of Chief Financial Officers shows that the Brexit shock that hit corporate spirits in the wake of the EU referendum has eased. After a collapse in CFO confidence in the wake of the referendum vote, optimism among CFOs has reached an 18-month high. The survey shows a decline in perceptions of risk in six of the eight key areas we poll CFOs on. Brexit continues to top the risk list, but with a lower reading than in the last two quarters. Crucially, two longstanding and acute sources of external risk for CFOs have diminished in importance – concerns about weakness in emerging markets and in the euro area have fallen to the lowest levels since we first asked this question at the end of 2014. The decline in concern about the euro area is the largest we have recorded for any category of risk, testifying to growing confidence about the region’s recovery. CFOs are switching away from the defensive strategies of the last year towards pro-growth policies. They have softened their laser-like focus on cost control and building cash flow, and are placing more weight on capital spending and introducing new products and services.

plans in the next three years has more than halved, from 66% to 30%, since the vote. The proportion expecting it to hit investment and M&A has also fallen sharply. Most CFOs think Brexit will have an adverse effect in the long term on the business environment but even here the degree of negativity has fallen in the last year. The UK’s exit from the EU is a long and uncertain negotiating game. The CFO Survey has demonstrated time and again that business sentiment is changeable. But what is clear is that the UK corporate sector enters the negotiating phase of the UK’s withdrawal from the EU in far better spirits than seemed likely in the months after last year’s referendum vote.

Ian Stewart Chief Economist 020 7007 9386 [email protected] Debapratim De Senior Economic Analyst 020 7303 0888 [email protected] Alex Cole Economic Analyst 020 7007 2947 [email protected]

Key contacts Ian Stewart Chief Economist 020 7007 9386 [email protected] Richard Muschamp CFO Programme Leader 020 7007 0724 [email protected] For current and past copies of the survey, historical data and coverage of the survey in the media and elsewhere, please visit: www.deloitte.co.uk/cfosurvey

Chart 1. CFO priorities: Expansionary vs defensive strategies

Arithmetic average of the % of CFOs who rated expansionary and defensive strategies as a strong priority for their business in the next 12 months 40% Defensive strategies

35% 30% 25% 20% 15%

CFOs believe that the headwinds from Brexit have eased. The proportion of CFOs who expect Brexit to reduce their own hiring

Authors

Expansionary strategies 2011

2012

2013

2014

2015

2016

2017

Expansionary strategies are introducing new products/services or expanding into new markets, expanding by acquisition and increasing capital expenditure. Defensive strategies are reducing costs, reducing leverage and increasing cash flow.

1

The Deloitte CFO Survey Q1 2017 | Brexit shock eases

CFOs less pessimistic about Brexit Business optimism continued to improve, hitting an 18-month high in the first quarter.

Chart 2. Business optimism

Net % of CFOs who are more optimistic about the financial prospects of their company than three months ago 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% -70% -80%

CFOs have continued to scale down their pessimism about the effects of Brexit. The proportion of CFOs who expect Brexit to reduce their own hiring plans in the next three years has more than halved, from 66% after the vote to 30% now. Over the same period, the percentage of CFOs expecting it to hit investment has fallen from 58% to 26% while those expecting Brexit to lower M&A activity are down from 40% to 11%.

In the long run, CFOs expect Brexit to have a negative impact on the overall environment for business but the degree of negativity has fallen since the referendum. 60% expect a worsening in conditions, down from 68% in July.

2008

2010

2011

2012

2013

2014

2015

2016

2017

Chart 3. Effect of Brexit on own spending and hiring decisions

% of CFOs who expect M&A activity, capital expenditure, hiring and discretionary spending by their business to decrease over the next three years as a consequence of Brexit 80%

74% 66%

70%

58%

60% 50% 40%

40%

20%

15%

35%

51% 50%

39% 30%

26% 11%

Mergers and acquisitions

2016 Q2

46%

19%

10% 0%

55% 40%

30%

2016 Q3

Capital expenditure 2016 Q4

Hiring

Discretionary spending

2017 Q1

Chart 4. Long-term impact of Brexit

% of CFOs who think the overall environment for business in the long term will be better/worse if the UK leaves the EU 80% 70% 60% 50% 40% 30% 20% 10% 0%

Better

2

2009

68%

66%

65%

13%

11%

14%

2016 Q2

2016 Q3

2016 Q4

Worse

60%

19%

2017 Q1


Decline in perceptions of risk CFOs have reported a decline in perceptions of risk in six of the eight key areas we poll them on. Brexit continues to top the risk list, but with a lower reading than in the last two quarters. Weak demand in the UK and the prospect of interest rate rises in the US and UK make up the top three risks. CFOs report a rise in concerns over policy uncertainty in the US and potential moves towards greater protectionism by the Trump administration. Meanwhile, two longstanding sources of external risk – weakness in emerging markets and the euro area – have diminished in importance. They are down to the lowest levels since we first asked this question at the end of 2014. The decline in concern about the euro area is the largest we have recorded for any category of risk, testifying to growing confidence about the region’s recovery. CFOs are also less concerned about the impact of insurgent parties on mainstream politics in the Netherlands, France and Germany, with it featuring near the bottom of the risk list. Chart 5. Risk to business posed by the following factors

Weighted average ratings on a scale of 0-100 where 0 stands for no risk and 100 stands for the highest possible risk

62 Effects of Brexit

55 55

Weak demand in the UK

51 53

The prospect of higher interest rates and a general tightening of monetary conditions in the UK and US

50 43

Policy uncertainty in the US and move towards greater protectionism by US administration

47 45

A bubble in housing and/or other real and financial assets and the risk of higher inflation

47 46

Poor productivity/weak competitiveness in the UK economy

44 52

Deflation and economic weakness in the euro area, and the possibility of a renewed euro crisis

40

Insurgent parties determining/influencing mainstream politics ahead of and after upcoming elections in Netherlands, France and Germany

38 38

Weakness and or volatility in emerging markets and rising geopolitical risks in Middle East/Ukraine

35 20

2016 Q4

30

40

50

60

70

2017 Q1

3


Shift towards expansion Cost reduction continues to remain the top priority for CFOs. But, compared to last quarter, they have softened their focus on defensive strategies such as reducing costs and increasing cash flow.

Chart 6. Corporate priorities in the next 12 months

% of CFOs who rated each of the following as a strong priority for their business in the next 12 months 45%

Reducing costs

42% 36%

Introducing new products/services or expanding into new markets

CFOs are placing greater emphasis on expansionary strategies such as introducing new products and services and increasing capital spending.

41% 41%

Increasing cash flow

34% 14%

Increasing capital expenditure

22% 18%

Expanding by acquisition

19% 9%

Raising dividends or share buybacks

11% 12%

Reducing leverage

9% 10%

Disposing of assets

7%

0% 2016 Q4

40%

50%

2017 Q1

100% 80% 60% 40%

Capital expenditure

Hiring

20%

Discretionary spending

0% -20% -40% -60% -80% -100%

4

30%

Net % of CFOs who expect UK corporates’ capital expenditure, hiring and discretionary spending to increase over the next 12 months

Decrease

Yet, on balance, they expect UK corporates to decrease spending in each area over the next 12 months.

20%

Chart 7. Outlook for capital expenditure, hiring and discretionary spending

Increase

CFO expectations for growth in capital expenditure, hiring and discretionary spending continued to improve in the first quarter.

10%

2011

2012

2013

2014

2015

2016

2017


Uncertainty down Uncertainty continued to be a key theme in the first quarter with 34% of CFOs rating current levels of external financial and economic uncertainty as high or very high. Perceptions of uncertainty have dipped since the last survey, however, and are further below their peak after last year’s referendum.

Chart 8. Uncertainty

% CFOs who rate the level of external financial and economic uncertainty facing their business as high or very high 70% 60% 50% 40% 30% 20% 10% 0%

Corporate risk appetite has improved for the third consecutive quarter but remains below long-term averages.

2011

2012

2013

2014

2015

2016

2017

Chart 9. Corporate risk appetite

% of CFOs who think this is a good time to take greater risk onto their balance sheets 80% 70%

26% of CFOs think now is a good time to take greater risk onto balance sheets.

60% 50% 40% 30% 20% 10% 0%

The outlook for corporate revenue growth has improved once again. A net 49% of CFOs expect UK corporate revenues to increase over the next year, up sharply since last summer. The outlook for operating margins remains challenging. On balance, CFOs expect operating margins to fall over the next year.

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Chart 10. Outlook for corporate revenues and margins

Net % of CFOs who expect UK corporates’ revenues and margins to increase over the next 12 months 100% 80%

Revenues

60% 40% 20% 0% -20% -40%

Operating margins

-60% -80%

2011

2012

2013

2014

2015

2016

2017

5


Credit conditions benign Chart 11. Cost and availability of credit

Net % of CFOs reporting credit is costly and credit is easily available 100%

80%

80%

60%

60%

Credit is costly

100%

40%

40%

20%

Availability of credit (RHS)

Credit is cheap

0%

0%

-20%

-20%

-40%

Cost of credit (LHS)

-60% -80%

-60%

-100% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Chart 12. Interest rate expectations

% of CFOs who expect the Bank of England's base rate to be at the following levels in a year’s time 60

53%

50

41%

40%

40

29%

30 20

12% 11%

10 0

7% 6%

0% 0% Below 0.25%

2016 Q4

Debt finance – bank borrowing and bond issuance – remains the most attractive source of funding for CFOs.

-40% -80%

-100%

In recent quarters CFOs have brought forward their expectations for rate rises. A significant majority – 71% – of CFOs now expect the Bank of England’s base rate to be above its current level of 0.25% in a year’s time.

20%

Credit is available Credit is hard to get

Financial conditions remain favourable for the large corporates on our survey panel, with CFOs continuing to view credit as being cheap and easily available.

0.25%

0.50%

0.75%

1%

1% 1% 1.25%

2017 Q1

Chart 13. Favoured source of corporate funding

Net % of CFOs reporting the following sources of funding as attractive 100%

Bank borrowing

6

Bond issuance

60% 40% 20%

Unattractive

Equity issuance has become more appealing on the back of stronger equity markets.

Attractive

80%

Equity issuance

0% -20% -40% -60%

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


CFO Survey: Economic and financial context The macroeconomic backdrop to the Deloitte CFO Survey Q1 2017 Continuing political uncertainty – including the Dutch general election, the run up to formal Brexit negotiations and some high-profile complications for the Trump administration – failed to derail the global recovery in the first quarter. A number of leading global growth indicators strengthened, with German business confidence reaching a near three-year high, optimism among UK manufacturers rising to its highest level since 1995 and US consumer confidence hitting its highest level since July 2001. For the first time since 2010, activity is picking up in both developed and emerging markets this year. Oil prices softened slightly in the first quarter but remained well above their levels at the start of 2016. Stronger growth and rising commodity prices drove up inflation across the West. UK inflation rose to 2.3% in February, its highest rate in more than three years and euro area inflation reached a four-year high. With euro area growth and inflation accelerating, the European Central Bank signalled victory in its fight against deflation. The Federal Reserve raised interest rates to 1.0% and stuck with previous projections for two further rate increases this year. UK and US equity markets remained at or near record highs, although rising rate expectations led to a sell-off in government bonds. UK GDP growth: Actual and forecast (%) 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% -7%

FTSE 100 price index

Forecasts

7500 7000

Quarter-on-quarter growth

6500 6000

Year-on-year growth 5500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Q1 2016

Q2 2016

Q3 2016

Source: ONS, Consensus Economics and Deloitte calculations

Source: Thomson Reuters Datastream

UK private and public sector job growth (thousands)

UK annual CPI inflation (%)

500 400 300 200 100 0 -100 -200 -300

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Private

Public

Source: Thomson Reuters Datastream

Q4 2016

Q1 2017

9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Source: Thomson Reuters Datastream

7

Two-chart summary of key survey messages Business optimism

Net % of CFOs who are more optimistic about the financial prospects of their company than three months ago 50 40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 -80

Long-term impact of Brexit

% of CFOs who think the overall environment for business in the long term will be better/worse if the UK leaves the EU 80% 70% 60% 50% 40% 30% 20% 10% 0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Better

68%

65%

13%

11%

2016 Q2

2016 Q3

66%

14%

2016 Q4

60%

19%

2017 Q1

Worse

About the survey This is the 39 th quarterly survey of Chief Financial Officers and Group Finance Directors of major companies in the UK. The 2017 first quarter survey took place between 8th and 22nd March. 130 CFOs participated, including the CFOs of 25 FTSE 100 and 53 FTSE 250 companies. The rest were CFOs of other UK-listed companies, large private companies and UK subsidiaries of major companies listed overseas. The combined market value of the 91 UK-listed companies surveyed is £376 billion, or approximately 15% of the UK quoted equity market. The Deloitte CFO Survey is the only survey of major corporate users of capital that gauges attitudes to valuations, risk and financing. To join our panel of CFO respondents and for additional copies of this report, please contact Anthea Neagle on 020 7303 0116 or email [email protected].

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