Post-election dip in confidence The Deloitte CFO Survey

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Q2 2017

The Deloitte CFO Survey Post-election dip in confidence In the wake of the General Election on 8th June, optimism among Chief Financial Officers has fallen back from the 18-month high seen in the first quarter. Despite speculation that the result of the election outcome could mean a closer longterm relationship between the UK and the EU, CFO concerns about Brexit have risen and it is seen as the top risk facing business. 72% of CFOs expect some negative long-term effects on the business environment as a result of the UK’s departure from the EU, up from 60% in the first quarter. The second quarter survey of CFOs took place between 12th and 27th June and provides the first insight into the thinking of major UK corporates in the aftermath of the UK General Election. CFO perceptions of uncertainty facing businesses rose in the second quarter, a development which seems to reflect both the outcome of the General Election and concerns about growth. Worries about UK growth have risen and are now seen as posing a greater risk to business than at any time in twoand-a-half years. Such concerns rank second on CFOs’ risk list after Brexit. For much of the last three years external risks have been the focus of CFO concern. But the worries about geopolitics and growth overseas, which dominated CFO concerns in 2015 and 2016, have receded.

Authors Ian Stewart Chief Economist 020 7007 9386 [email protected]

A recovery in emerging markets and a pickup in growth combined with an easing of political risk in the euro area, have pushed both to the bottom of the worry list. Today CFOs see Brexit and the prospect of slower UK growth as being the main risks.

Debapratim De Senior Economic Analyst 020 7303 0888 [email protected] Alex Cole Economic Analyst 020 7007 2947 [email protected]

Business sentiment has been on a roller coaster ride in the last 18 months, slumping on the surprise referendum result before staging a strong recovery and then falling back in the wake of the General Election.

Rebecca Porter Economic Analyst 020 7007 5728 [email protected]

Key contacts Ian Stewart Chief Economist 020 7007 9386 [email protected]

Although CFO confidence has taken a knock since the election, sentiment and risk appetite are well above the levels seen last summer. Perceptions of uncertainty are also lower. Favourable financial conditions and an improving global backdrop are partially offsetting the effects of domestic uncertainties for UK CFOs.

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%

Better

68%

65%

66%

13%

11%

14%

2016 Q2

2016 Q3

2016 Q4

72% 60%

19% 8% 2017 Q1

2017 Q2

Worse

1

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

Optimism down Business optimism fell sharply in the second 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%

CFO pessimism about the effects of Brexit has edged up. But it remains at substantially lower levels than right after the EU referendum. A third or more expect Brexit to reduce their own investment and hiring plans over the next three years. 17% expect it to lower M&A activity over the same period.

2008

2009

2013

2014

2015

80%

2016

2017

74%

70%

66% 58%

60% 50% 40%

40%

40%

30%

35%

15%

33%

38%

30%

19%

10% 0%

55% 51%50% 49%

46% 39%

26%

20%

17% 11%

Mergers and acquisitions

Capital expenditure

2016 Q3

2016 Q4

Hiring

2017 Q1

Discretionary spending 2017 Q2

Chart 4. Outlook for capital expenditure, hiring and discretionary spending Net % of CFOs who expect UK corporates’ capital expenditure, hiring and discretionary spending to increase over the next 12 months

Increase

100% 80% 60%

Capital expenditure

40% 20%

Hiring Discretionary spending

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

2

2012

% 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

Decrease

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

2011

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

2016 Q2

The outlook for capital expenditure, hiring and discretionary spending has deteriorated in the second quarter.

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2011

2012

2013

2014

2015

2016

2017

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

Brexit tops risk list CFOs continue to cite Brexit as the biggest and a growing risk to their businesses. Weak demand in the UK and the prospect of rate rises in the US and UK, make up the top three risks. Concerns over weak demand in the UK have risen to the highest level since we started asking this question at the end of 2014. Meanwhile, the risks of an asset price bubble, and policy uncertainty and greater protectionism in the US have diminished in importance. Concerns over two major sources of external risk – weakness in emerging markets and the euro area, which make up the bottom of the list – have continued to decrease and are now at the lowest levels since the end of 2014.

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

60 Effects of Brexit

55 57

Weak demand in the UK

51

50

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

50 46

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

47 45

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

47 44

Poor productivity/weak competitiveness in the UK economy

44 39

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

40 32

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

35 20

2017 Q2

30

40

50

60

70

2017 Q1

3

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

Corporate strategies defensive The balance of corporate strategies has tilted further towards the defensive. CFOs have sharpened their focus on expansionary strategies such as introducing new products and services, and expanding by acquisition.

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 46%

Reducing costs

42% 42%

Introducing new products/services or expanding into new markets

But, relative to the first quarter, they are placing much greater emphasis on defensive strategies such as cost reduction, which remains the top priority, increasing cash flow and reducing leverage.

41% 36%

Increasing cash flow

34% 25%

Expanding by acquisition

19% 17%

Increasing capital expenditure

22% 14%

Reducing leverage

9% 8%

Raising dividends or share buybacks

Disposing of assets 0% 2017 Q2

CFOs have become significantly more defensive in the second quarter, more than offsetting their slightly sharper focus on expansionary strategies.

11% 4% 7% 10%

20%

30%

40%

2017 Q1

Chart 7. 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

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.

4

50%

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

Uncertainty up CFO perceptions of uncertainty have risen in the second quarter survey, conducted immediately after the surprise outcome of a hung parliament in the UK General Election.

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%

43% of CFOs rate current levels of external economic and financial uncertainty as high or very high.

40% 30% 20% 10% 0%

Corporate risk appetite has decreased slightly in the second quarter. 22% of CFOs think now is a good time to take greater risk onto their balance sheets, a reading well below the long-term average.

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2012

2013

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

The outlook for corporate revenue and margin growth has deteriorated in the second quarter. A net 28% of CFOs expect revenues to increase over the next 12 months, down sharply from the first quarter. On balance, CFOs expect operating margins to fall over the same period.

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

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

Financing conditions remain benign for the large corporates on our survey panel.

Chart 11. Cost and availability of credit

CFOs continue to view credit as being cheap and easily available.

Credit is costly

Favourable credit conditions 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%

0%

-20%

-20%

-40%

Nonetheless, a sizeable majority – 59% – expect the Bank of England’s base rate to be above its current level of 0.25% in a year’s time, down from 71% in the first quarter.

-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 60%

53%

50%

41%

40%

34%

29%

30%

21%

20% 10% 0%

11% 0%

6%

0%

Below 0.25%

2017 Q1

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

-60%

-80% -100%

CFOs seem to have pushed back their expectations for rate rises.

-40%

Cost of credit (LHS)

-60%

0.25%

0.50%

0.75%

3%

1% 1%

1%

1.25%

2017 Q2

Chart 13. Favoured source of corporate funding

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

Bank borrowing

6

60%

Bond issuance

40% 20%

Unattractive

Equity issuance is still less appealing, with a fall in attractiveness in the second quarter.

Attractive

80%

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%

The Deloitte CFO Survey Q2 2017 | Post-election dip in confidence

CFO Survey: Economic and financial context The macroeconomic backdrop to the Deloitte CFO Survey Q2 2017 The UK General Election on 8th June unexpectedly delivered a hung parliament, creating new political uncertainties. British households saw a further squeeze on earnings as inflation rose to 2.9% in June. In a sign that rising prices and weak pay growth are squeezing consumers, the household savings ratio fell to 1.7%, its lowest level since 1963. In contrast, British manufacturing activity grew at its fastest pace in three years and the Confederation of British Industry’s measure of export order books climbed to the highest level in almost 30 years on sterling weakness and a pickup in global growth. With a synchronised recovery underway in advanced and emerging markets the International Monetary Fund revised up its global growth forecasts for 2017. A convincing victory for the pro-EU centrist, Emmanuel Macron, in France’s presidential election helped ease perceptions of political risks in Europe. Survey data indicated an acceleration in the euro area recovery, with consumer confidence rising to its highest level since 2007 and German business sentiment rising to its highest ever level. Euro area, US and UK equity prices rose while government bond prices fell as investors anticipated a tightening of monetary policy in advanced economies. The Federal Reserve demonstrated its confidence in the US recovery by raising interest rates for the third time on 14th June. UK GDP growth: Actual and forecast (%)

FTSE 100 price index Forecasts

4% 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% -7%

7,500 7,000 6,500 6,000

Quarter-on-quarter growth

5,500 5,000 4,500

Year-on-year growth

4,000 3,500

20072008200920102011201220132014201520162017

Source: ONS, Consensus Economics and Deloitte calculations

UK private and public sector job growth (thousands) 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

3,000 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Thomson Reuters Datastream

UK annual CPI inflation (%) 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1%

1992

1996

2000

2004

2008

2012

2016

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

Uncertainty

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

70%

70%

50%

60%

30%

50%

10%

40%

-10%

30%

-30%

20%

-50%

10%

-70% -90%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

About the survey This is the 40 th quarterly survey of Chief Financial Officers and Group Finance Directors of major companies in the UK. The 2017 second quarter survey took place between 12th and 27th June. 122 CFOs participated, including the CFOs of 22 FTSE 100 and 54 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 92 UK-listed companies surveyed is £509 billion, or approximately 20% 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]

This publication has been written in general terms and we recommend that you obtain professional advice before acting or refraining from action on any of the contents of this publication. Deloitte LLP accepts no liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Deloitte LLP is the United Kingdom affiliate of Deloitte NWE LLP, a member firm of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”). DTTL and each of its member firms are legally separate and independent entities. DTTL and Deloitte NWE LLP do not provide services to clients. Please see www.deloitte.com/about to learn more about our global network of member firms. © 2017 Deloitte LLP. All rights reserved. Designed and produced by The Creative Studio at Deloitte, London. J12682