Deloitte Private Market Observations August 2010
Private Matters Issue 8
The current economic landscape is characterised by waning business confidence with a number of internal and external economic and political factors creating a great deal of uncertainty around the country’s economic outlook.
The characteristics of a two speed economy are still evident and we are observing further divergence in conditions being experienced between the SME market and the top end of town, particularly with respect to access to funding.
Top end of town
Over the past month over five hundred larger companies in the US, UK and Continental Europe have published their second quarter results. These results show a rebound in corporate profitability. When we looked closer at the figures it is interesting to see that while revenues are improving for many sectors, cost cutting has been vital to delivering stronger profits. For example, revenues of the 336 S&P500 companies which had reported second quarter results at the time of writing had risen 9% but profits have risen four times as fast, by 36%.
Despite this there remains a high number of cautious or negative outlook statements reflecting the levels of uncertainty about the future.
The Q2 Deloitte 2010 CFO Survey was launched in late July and comprised responses from 89 CFOs from the ASX.
The Survey found that CFOs’ confidence about their firm’s financial prospects has dipped. Although 40% still remain more optimistic than they were three months ago, this is the lowest reading since the launch of the survey in 2009. The principle causes for this seems to be uncertainty around the impact of the European sovereign debt issues and the increased cost of credit. However despite these CFOs believing that credit is now more expensive, there was a growing trend towards those that thought it was more readily available.
Interestingly, while the external environment is impacting confidence, underlying business performance is still on track. 83% of CFOs said that the second quarter revenues of their companies were in line with or above expectations.
Waning Confidence – The Evidence
An analysis of three key business surveys showed a significant shift in business sentiment in recent time. The CFO Survey showed that business sentiment is at its lowest confidence reading since the survey began. The NAB’s Business Confidence Index has fallen for five straight months in a row; and our own Black Ink Survey which canvasses the opinion of suburban legal and accounting firms confirmed the lowest recording of positive sentiment since the survey began two years ago.
Waning Confidence – Likely Causes
Clearly business confidence was dented by the sovereign risk issues which raised fears about the speed of recovery and access to capital. On top of that election nerves, including the abrupt installation of Prime Minister Julia Gillard at the end of June, hasn’t helped matters. Finally data showing the US recovery is weaker than forecast is placing additional pressure on emerging markets to lift global growth and is raising the fears of a double dip recession.
Reasons to be positive
However there are reasons to be positive. Despite some (perhaps necessary) slowing in China’s growth, our largest trading partner has overtaken Japan as the world’s 2nd leading economy. In Europe the vast majority of banks passed the stress test and there is now a safety fund in place to support any future sovereign debt problems. Generally many companies are simply in better shape than they were pre-GFC due to:
- Smart companies cutting unnecessary costs out of their business – running leaner and meaner
- Leverage being taken out of the system
- Increased realism around sustainable growth plans and better alignment of decision making to sensible core strategies.
These measures leave many Australian businesses, either well poised to capitalise on growth should the recovery continue, or well positioned to weather any slow down.
Evidence of our two speed economy is still strong. The media are still reporting that some of the weakest operating conditions are still being felt in retail and construction while other sectors such as mining and utilities are very strong. What many of these stories are not yet telling us is that for many retailers the results have been surprisingly good. ANZ Banking Group’s August property report notes that retail turnover is holding at healthy levels, 8 percent above the level before the global financial crises. It’s true consumer sentiment has been fragile and many retailers have been responding with heavy discounting to drive sales. But those businesses with strong brands that have been able to resist excessive discounting have fared the slow down very well.
We note that many sensible businesses are continuing to keep a very close eye on costs because of the uncertainty about the stability of this recovery.
Access to funding
While aggregate numbers suggest an easing in liquidity, it appears that this is not being applied evenly across the board. Banks are freeing up liquidity for their safer clients and there is anecdotal evidence to suggest that SMEs are not getting the same access to credit. Liquidity for the mid market is still tight with cash flow and working capital remaining among the biggest issues for many SMEs. We are seeing increasing concerns from business owners about the inability to obtain finance. The level of distress found in SMEs at present is evidenced by the number of businesses that have sought a delay in payment to the Australian Tax Office (ATO).
Our insolvency teams are still extremely busy and expect to be so for another couple of years. One of the unfortunate side effects of the stimulus measures is that a number of underperforming businesses have been able to hang on. The removal of the stimulus together with an uptick in interest rates, lack of available credit and pressure from banks may see many of these businesses really start to struggle during the recovery.
Sentiment for M&A activity is becoming more positive and there is support back in the lending market for sensible deals in attractive sectors. Certainly in our experience many more clients are poised to pursue opportunities this year. The Deloitte CFO Survey saw growth by acquisition rising as a top priority as there was also a greater number of respondents who thought that stocks are now undervalued.
Source: CFO Survey July 2010 - Deloitte
Private equity is now back in the market as businesses are actively looking to invest funds that were raised pre-GFC now that debt markets have eased. These funds also have a strong sell side focus as they seek to deliver results to drive new fundraising. FY11 has seen the return of big private equity back into the local market, with many international investors seeing Australia as a good part of the world to invest in.
Perhaps a slightly different source of empirical evidence for deal activity is the data rooms provided for transactions, in this case by a firm called Intralinks which may be seen a leading indicator of M&A activity.
Use of deal rooms bottomed at the end of last year and has risen steadily every quarter until June.
Continuing volatility in global markets has stalled the recovery seen in IPO activity in the first half of FY10. The price performance of IPOs is still anchored in negative territory. The fall in share price relative to listing price of the larger floats earlier in the year has added to the difficulties for companies planning to raise equity and increased the likelihood of exits via trade sale.
Our view is that IPO activity will likely continue at current levels for some time, with vendors continuing to look at exits via trade sales or raising capital from other sources.
For further information please contact:
Austin Scott, Partner, Deloitte Private, Tel: +61 2 9322 3861.