Sara Yates, FX Strategist provides monthly commentary on the latest developments for Sterling, FX and interest rates.
The economic outlook remains uncertain, but more companies are investing for growth. Dave Davies, Atif Malik, and Hetal Popat tell Graham Buck about the renewed appetite for borrowing.
As the second half of 2011 progresses, there is renewed volatility on both sides of the Atlantic. Barack Obama recently announced a US$450m jobs plan in an attempt to revive a stalled US economy, while Europe’s sovereign debt crisis continues to unsettle the financial markets, accompanied by continued uncertainty around the future of the Euro.
These events have obscured the fact that while times remain challenging, more encouraging news is also emerging, with the UK showing modest economic growth in the second quarter. Although this clearly has to be tempered by an uncertain macro outlook, even meagre growth, provided it is consistent, encourages businesses to turn their thoughts to investment.
Since the start of 2011, a number of Barclays clients have taken the decision to borrow and invest for growth. There is much interest in the various funding options available and their respective benefits; with a range of options available to businesses of all sizes.
Business confidence remains vulnerable to several macro-economic issues, so is tempered with a degree of apprehension. Corporates recognise that an unexpected event has the potential to change the mood and few executives have a gung-ho attitude.
But it is difficult for companies to sit on their cash reserves when yields are low, and hard to justify to shareholders. Companies are keen to invest but do so with an element of caution. A business and investment-led steady recovery is needed, to replace the credit-fuelled consumer boom.
Dave Davies, Director, Debt Finance, Barclays says: ‘This means an increasing focus on manufacturers, whose fortunes are vital in rebalancing the economy. Many continue to invest and are now confident enough, as well as ready and able to take on a certain level of debt, with some bullish enough to step up their capital investment. One of the key drivers for manufacturers’ capital investment is to improve their margins over the long term.’
A company’s investment strategy will reflect its industry sector and where it is based geographically. It also depends on the attitude of the management team. For example, construction businesses are investing in their land banks for future growth and taking advantage of cheaper suppliers, producing tangible benefits in cost containment and cash management.
A tangible effect of the downturn is that most businesses reined in spending, reduced costs and those that navigated the downturn have emerged fighting fit. Many have now reached a point in the business cycle when they need to reinvest in their company and are seeking appropriate financing solutions to support this.
In some cases, corporates are now rehiring when employees depart, rather than leaving vacancies unfilled as many did during the downturn. A recent Manpower survey indicates that slightly more employers expect to expand their workforce over the coming quarter than to shrink them. Certain sectors, such as engineering and IT, have seen relatively strong growth with a rise in job vacancies.
Hetal Popat, Director, Barclays says: ‘There is increasing demand for individuals with compliance skill sets in professional services, such as audit, who are equipped for Europe’s new regulatory regimes. Other sectors faring well are engineers for infrastructure projects and business support services. Facilities management is a growing market, as public sector contracts are outsourced to achieve cost savings. Recruitment by the technology sector also remains strong, particularly in the more complex areas, and was resilient, even during the downturn.’
Inevitably there are exceptions. Recent UK job statistics demonstrate a further increase in unemployment, with youth unemployment in particular seeing a large rise. Retail, traditionally a tough sector, is affected by weak consumer confidence, highlighted by flat retail sales in August.
Higher charges imposed by energy and utility companies are eroding the discretionary spend of both consumers and businesses. There is also evidence of a continuing regional division, with London and the South East enjoying more buoyant conditions than northern areas.
Major national and international corporations, particularly in the support services sector, are investing worldwide as they attempt to diversify their revenue streams. Civil engineers are looking to the developing world, while manufacturers have a growing interest in supply chains from China and other Asian countries. Despite volatility from the Arab Spring, the Middle East is among the regions favoured for investment, as are the rapidly developing economies of Brazil, China and India. Nearer to home, there are also attractive acquisition opportunities in Europe.
UK companies are thinking globally; helped by easier access to overseas markets. The global economy relies increasingly on China and India as the US’s traditional dominance is eroded. This is evidenced by the £1.4bn trade agreement signed between Britain and China in June 2011; although many would argue this is nowhere enough to drive the UK economic recovery at present.
There is also encouraging evidence of capital investment by manufacturers to improve their trading performance. Barclays has seen clients setting up significant export operations, and supporting them with further investment in infrastructure and information technology.
Many corporates are looking beyond outsourcing to overseas markets, by adding a local presence enabling them to sell more effectively in those countries. This is occurring both in the main economic powerhouses and the ‘next wave’ of low-cost economies, such as Indonesia and Vietnam.
This rebalancing of activities is reflected in more limited investment at home, where companies are responding to a shrinking number of public sector contracts, by refocusing on the private sector. Activity in the mid-market, has been seen in the defensive sectors, where businesses have looked to expand on the basis of ongoing demand and have added to their presence with several acquisitions.
After a two year low, merger and acquisition (M&A) levels showed significant recovery last year. Dealogic reports that with a total value of US$183bn, the UK’s M&A market was most active after the US.
Atif Malik, Director, Barclays says: ‘There has been renewed corporate activity recently in key sectors, such as energy and natural resources, and more selectively in others.
‘While volumes remain above 2008-09, the macro picture is also important to continuing this trend in a context where organic growth is likely to remain subdued in the near-term for most companies. That said, with the ongoing general economic turbulence, corporates are likely to approach M&A deals cautiously, ensuring they deliver real value in the short-term coupled with sensible valuation metrics.
Barclays is actively working with a wide range of companies from SMEs to FTSE listed corporates on possible investment opportunities. Businesses with retained sizeable cash piles, and robust cash flows, are ready to exercise that strength over weaker competitors.
Corporates have become more adept at managing their cash to maintain liquidity. Typically they will conduct considerable pre-planning before taking on debt. The right working capital facilities are essential, particularly for companies trading overseas.
Malik says: ‘Treasurers and their colleagues have become far more cash-focused and carefully scrutinise what the company is spending. Everyone is seeking to manage working capital better and is keen to have their medium-term debt and capital in place.’
In the larger corporate space, the first half of 2011 was dominated by re-financings, with loan volumes up by 39% on first half 2010 (source: Dealogic). Many companies that struck deals in 2007-08 have re-financed well ahead of schedule to take advantage of favourable conditions. In the first half of the year, Barclays saw businesses utilise their available capacity, to reduce borrowing costs and return to the market.
‘Trade invoice discounting has been widely adopted and corporates are more adept at managing their debtor books’ says Popat. ‘At the start of the downturn, Barclays saw a strong increase in demand for credit scoring products; an effective tool to provide SMEs with credit evaluations and ratings on their counterparties.’
Despite the prospect of record low interest rates extending into 2012, hedging strategies remain an important tool for any company. While various options are available, capped rates – which basically operate in a similar way as they do for mortgage products – are now one of the most popular.
Choosing whether or not to invest at the present time is a tough call. The decision is largely determined by a corporate’s financial headroom, or its ability to absorb the peaks and troughs of the business cycle. Corporates require a large degree of financial flexibility so they are not caught out; for example should a customer fail to pay on time.
Asset finance, traditionally embraced by larger corporations, has gained in popularity as a means of funding capital investment by spreading the cost of funding and conserving cash. Trade products, where the bank guarantees that the business will still be paid if the supplier defaults, are also in demand.
Davies says: ‘A number of corporates have opted for invoice discounting, which can free up two to three times the amount of cash from the debtor book, compared to typical overdraft based products. Cash-rich businesses, faced with a prolonged period of low interest rates, have sought to enhance yield through structured or equity-type bonds.’
‘For private businesses the main concern is whether they have funding to build new plant or re-equip their fleet, in the face of a challenging economic environment.’
An interesting resource for SMEs seeking to invest is the Business Growth Fund. This is a £2.5bn equity investment capital fund, principally for those with annual sales of £10m to £100m, that seek financing up to £10m.
Backed by Barclays and four other major UK banks, the Fund is an attractive addition to the armoury of smaller businesses with limited debt capacity and those keen to avoid having private equity wielding control.
Malik says: ‘A noticeable trend in the large corporate space over the past 18 months has been bond investors’ readiness to support corporates as they look to diversify their funding sources. This complements the loan market which had experienced a period of stability over the same period. Whilst the first half of 2011 in the UK market has seen an increased proportion of bond finance, in the overall capital raising paradigm, it still remains heavily weighted towards loan finance, and in uncertain times corporates’ relationships with core banks remain key.’
Many well-known companies have issued high-yield bonds during 2011, to benefit from the increased flexibility they can offer. The appetite for them has been strong as comparative rates are low, but demand remains heavily affected by the macro economic picture. There have been some unrated public bonds, but these are few and far between. The US Private Placement market remains active and provides attractive financing, primarily for listed borrowers.
In the current challenging economic climate, corporate are taking measured steps towards investing for future growth, while continuing to conserve cash.
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The views expressed by the author do not necessarily reflect the views of the Barclays Bank PLC Group nor should they be taken as statements of policy or intent of the Barclays Bank PLC Group.
The Barclays Bank PLC Group takes no responsibility for the veracity of information contained in third party articles and no warranties or undertakings of any kind whether express or implied, regarding the accuracy or completeness of the information is given. The Barclays Bank PLC Group takes no liability for the impact of any decisions made based on information contained and views expressed in this article.
This article was first published in a special report 'A Question of Confidence - How British companies can break into emerging markets' by Business Voice in November 2011.
Barclays is a trading name of Barclays Bank PLC and its subsidiaries. Barclays Bank PLC is registered in England and authorised and regulated by the Financial Services Authority (FSA No. 122702).
Registered Number is 1026167 and its registered office 1 Churchill Place, London E14 5HP.
March 2012.
Sara Yates, FX Strategist provides monthly commentary on the latest developments for Sterling, FX and interest rates.
