Optimism bounces The Deloitte CFO Survey

Q3 2017

The Deloitte CFO Survey Optimism bounces Business confidence has been on the rise in the US, Europe and Japan since last summer. In the UK domestic events have been in the driving seat, leading to big ups and downs in sentiment among UK Chief Financial Officers. CFO optimism collapsed in the wake of the EU referendum vote, rebounded in the second half of 2016 before dropping on the result of June’s General Election. Our latest survey shows a bounce back from the post-election lows with optimism close to levels seen at the end of last year. CFOs believe the environment has become less uncertain, with perceptions of uncertainty dropping to almost half the levels prevailing immediately after the EU referendum. CFO concerns over Brexit have also eased, with 60% of CFOs expecting the UK’s exit from the EU to affect the business environment adversely, down from 72% in the second quarter. Nonetheless, CFOs continue to see Brexit as the top risk facing their businesses. Almost a third expect to reduce investment over the next three years as a result of Brexit and 36% expect it to hit hiring. CFOs rate weak UK demand as the second greatest risk, with prospects for higher interest rates in third place. CFOs have brought forward their expectations for a UK rate rise and 92% now expect base rates to be higher than the current 0.25% level in a year’s time.

Authors

The post-referendum surge in inflation also seems to be squeezing corporate margins. CFOs report that cost pressures are running at the highest level in more than six years. As a result, while optimism and expectations for revenues have recovered from last year’s lows, profit expectations continue to languish. Businesses are rather more upbeat today than in July and see fewer risks in the world. Nonetheless, perceptions of uncertainty remain elevated and Brexit continues to top the CFO worry list. With margins under pressure CFOs are operating cautiously. It is testament to the changeable business environment that eight years into the UK recovery cost control is the top balance sheet priority for major UK corporates.

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] Rebecca Porter Economic Analyst 020 7007 5728 [email protected] Tom Simmons Economic Analyst 020 7303 7370 [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. 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 (excludes ‘little changed’) 80% 70% 60% 50% 40% 30% 20% 10% 0%

68%

65%

66%

13%

11%

14%

2016 Q2

2016 Q3

2016 Q4

Better

72% 60%

60%

19% 8% 2017 Q1

2017 Q2

14% 2017 Q3

Worse 1

The Deloitte CFO Survey Q3 2017 | Optimism bounces

Optimism up After its post-election drop, business optimism has recovered in the third 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%

Perceptions of uncertainty dipped since the last survey, back to levels seen before the General Election and is now running at almost half their post-referendum highs in July last year.

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Chart 3. Uncertainty

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

34% of CFOs rate current levels of external financial and economic uncertainty as high or very high.

40% 30% 20% 10% 0%

Corporate risk appetite has seen a modest rise in the third quarter but remains well below its longterm average.

2011

2012

2013

2014

2015

2016

2017

Chart 4. Corporate risk appetite

% of CFOs who think this is a good time to take greater risk onto their balance sheets 80% 70% 60% 50% 40% 30% 20% 10% 0%

2

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017


Brexit tops risk list Despite a reduction in concerns, CFOs continue to cite Brexit as the biggest risk to their businesses. Weak demand in the UK and the prospect of rate rises in the US and UK, which have both diminished in importance, make up the top three risks. Concerns over weak demand feature as a prominent risk for the second consecutive quarter. The risks of an asset price bubble and poor productivity in the UK have also receded. As growth picks up in the euro area, concerns over economic weakness and deflation in the region have dropped to the lowest levels since the end of 2014. Meanwhile, the risk posed by weakness in emerging markets and geopolitical tensions has risen slightly.

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

58

Effects of Brexit

60 53

Weak demand in the UK

57 49

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

50 45

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

46 43

Poor productivity/weak competitiveness in the UK economy

44 38

Policy uncertainty in the US and move towards greater protectionism by US administration 35

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

39 33

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

32 20

2017 Q3

30

40

50

60

70

2017 Q2

3


Operating costs rising CFO pessimism about the effects of Brexit has edged lower. 30% or more now expect Brexit to reduce their own investment and hiring plans over the next three years. 15% expect it to lower M&A activity over the same period.

Chart 6. 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%

70%

66% 58%

60% 50%

33% 30% 26%

30%

0%

Mergers and acquisitions

2016 Q2

However, expectations of an increase in operating costs have grown. A net 71% of CFOs expect operating costs to increase over the next 12 months, the highest reading in more than six years.

2016 Q3

2016 Q4

Hiring

2017 Q1

Discretionary spending 2017 Q2

2017 Q3

100% Increase

80% 60% 40%

Capital expenditure

Hiring

20%

Discretionary spending

0% -20% -40% -60% -80% 2011

2012

2013

2014

2015

2016

2017

Chart 8. Outlook for corporate revenues and margins

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

Revenues

80%

Operating costs

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

Operating margins

-60% -80%

4

Capital expenditure

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

-100%

The outlook for corporate revenue and margin growth remains largely unchanged in the third quarter.

38% 36%

30%

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

Decrease

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

55% 51%50% 49%50%

19% 17%15% 15% 11%

20% 10%

The outlook for capital expenditure, hiring and discretionary spending has improved slightly in the third quarter.

40% 35%

40%

40%

46% 39%

2011

2012

2013

2014

2015

2016

2017


Focus on defensive strategies CFOs are placing less emphasis on expansionary strategies such as introducing new products and services and expanding by acquisition. They have also softened their focus on defensive strategies such as cost reduction, which still remains the top priority, increasing cash flow and reducing leverage.

Chart 9. 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 41%

Reducing costs

46% 39%

Introducing new products/services or expanding into new markets

42% 35%

Increasing cash flow

36% 20%

Expanding by acquisition

25% 17%

Increasing capital expenditure

17% 15%

Raising dividends or share buybacks

8% 10%

Reducing leverage

Disposing of assets 0% 2017 Q3

On balance, CFOs maintain a defensive stance despite placing less emphasis on both defensive and expansionary strategies relative to the second quarter.

14% 5% 4% 10%

20%

30%

40%

50%

2017 Q2

Chart 10. 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%

Expansionary strategies 2011

2012

2013

2014

2015

2016

2017

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

5


The large corporates on our survey panel have easy access to credit.

Chart 11. Cost and availability of credit

CFOs continue to view credit as being easily available and close to its cheapest in ten years.

Credit is costly

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

80%

80%

60%

60%

40%

40%

20%

20%

Availability of credit (RHS)

Credit is cheap

0%

A large majority – 92% – expect the Bank of England’s base rate to be above its current level of 0.25% in a year’s time, up from 56% in the second quarter.

-20%

-40%

-60%

-80%

-80% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-100%

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 50%

50% 41%

40%

34%

33%

30% 21%

20% 8%

10% 0%

0%

3%

0%

Below 0.25%

2017 Q2

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

-40%

Cost of credit (LHS)

-60% -100%

CFOs have brought forward their expectations for rate rises.

0%

-20%

0.25%

0.50%

0.75%

7%

1% 2%

1%

1.25%

2017 Q3

Chart 13. Favoured source of corporate funding

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

Bank borrowing

Equity issuance remains relatively less appealing.

Attractive

80% 60%

Bond issuance

40%

Unattractive

20%

6

Equity issuance

0% -20% -40% -60%

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Credit is available Credit is hard to get

100%


CFO Survey: Economic and financial context The macroeconomic backdrop to the Deloitte CFO Survey Q3 2017 The momentum in the global recovery picked up as growth became more synchronised across countries. Growth in the euro area has been particularly strong and the European Central Bank (ECB) now expects it to reach 2.2% in 2017, the fastest rate in a decade. Business and consumer confidence was buoyant, particularly in the euro area and the US. Business confidence in Japan reached a 25-year high and the economy posted its longest unbroken period of growth in more than a decade. In the UK, growth remains subdued and although unemployment is at its lowest level in 42 years, wage pressure has not yet emerged. The weakness of sterling has made British exports more competitive, with survey data showing that manufacturing export orders are close to their highest levels in 20 years. With high levels of consumer debt and inflation running at 2.9%, there is renewed speculation that the Bank of England will raise rates at its next meeting in November. Other central banks have also begun to normalise monetary policy. Having raised rates four times since 2015, the US Federal Reserve plans to start unwinding its Quantitative Easing (QE) programme at the end of October. Meanwhile, the Bank of Canada has begun to raise rates and the ECB also intends to announce how it plans to unwind its QE programme at the end of October. UK GDP growth: Actual and forecast (%)

FTSE 100 price index Forecasts

4%

7500 7000

3%

6500

2% 1%

6000

0%

Quarter-on-quarter growth

-1%

5500 5000

-2% -3%

4500

-4% -5%

Year-on-year growth

-6% -7%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: ONS, Consensus Economics and Deloitte calculations

UK private and public sector job growth (thousands)

4000 3500 3000 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: Thomson Reuters Datastream

UK annual CPI inﬂation (%)

500

9%

400

8%

300

7%

200

6%

100

5%

0

4%

-100

3%

-200

2%

-300

1% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Private

Public


0% -1%

1993

1997

2001

2005

2009

2013

2017


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

Outlook for corporate revenues and margins

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

70%

100%

50%

80%

30%

60% 40%

10%

20%

-10%

0%

-30%

-20%

-50%

-40%

-70% -90%

Operating costs

Revenues

Operating margins

-60% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-80%

2010

2011

2012

2013

2014

2015

2016

2017

About the survey This is the 41st quarterly survey of Chief Financial Officers and Group Finance Directors of major companies in the UK. The 2017 third quarter survey took place between 14th September and 4th October. 102 CFOs participated, including the CFOs of 20 FTSE 100 and 40 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 75 UK-listed companies surveyed is £416 billion, or approximately 16% 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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