EY - CFOs confident despite uncertainty

CFO need to know | CFO poll results

CFOs confident despite uncertainty

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Leading CFOs confident in corporate finances, despite economic uncertainty

The quarterly CNBC Global CFO Council provide a snapshot of how CFOs from some of the world's leading companies are responding to global events, macroeconomic changes and emerging business issues, and how they see this impacting their organization's strategies.

Here, Tom McGrath, EY Americas Senior Vice Chair – Accounts, Julie Tiegland, EY Global Accounts Leader and Patrick Winter, Deputy Managing Partner, Asia-Pacific share their insights on the third quarter 2014 results.

  • A global paradox

    The global economic environment can seem somewhat baffling at present. On the one hand, economic growth remains fragile and the global economy is still vulnerable to shocks.

    Yet corporate earnings are strong and stock-market valuations continue to reach record levels. How are companies achieving this?

    The CNBC Global CFO Council survey suggests that one reason may be because they have adapted to the new reality and put in place a more disciplined approach to growth, costs and major strategic initiatives that is enabling them to manage through the uncertainty.

  • Subdued economic performance

    CFOs remain cautious about the economic picture. Globally, 47% of CFOs polled consider that the global economy is modestly improving. The balance sees it as either stable (25%) or modestly declining (28%).

    There is more optimism in Asia, with a large majority seeing the global economy as modestly improving. US CFOs are also positive about their own domestic economy, with 71% seeing it as modestly improving. Overall, however, views on the economy are distinctly mixed.

    EY - What is your assessment of the global economy today?

    This is also true when we look at some of the underlying drivers of economic health. Just 15% of CFOs consider consumer confidence to be strong, and just 24% and 25% respectively say the same about consumer demand and employment growth.

    The leading risk they see to their business at present is economic: weakening consumer demand in the US and Europe, and softer growth in China.

    But Patrick Winter, Asia-Pacific Deputy Area Managing Partner at EY, argues that fears of slowing growth in China are overplayed.

    “Yes, the economy has slowed from its previous rate of expansion, but this still remains one of the biggest opportunities in the world from a growth perspective,” he says.

    “The APAC region as a whole remains hugely appealing for companies worldwide and most will not consider short-term falls in growth rates to be a major concern.”

    EY - Based on the current economic climate, please rate the health of the following business conditions?

    EY - Please rank in order the following choices, from the largest to the smallest external risk factor, currently faced by your business.

    This mixed sentiment reflects a fairly divergent economic performance globally, even within regions.

    “We see considerable diversity,” says Julie Teigland, Accounts Leader for EMEIA at EY.

    “In some places, there are good reasons for optimism, such as the recent change of leadership in India, which heralds a new, business-friendly government. But, there are also countries that have not been so successful in carrying out the necessary economic reforms.”

    Continued caution also reflects geopolitical risks, including developments in east Ukraine involving Russia and the associated tensions and sanctions rounds between Russia and the West, as well as the expansion of the Islamic State jihadist movement in the Middle East.

    Indeed, CFOs globally see Russia and Eastern Europe as the region most susceptible to a slowdown over the next six months, and views are also negative on the Middle East. Concerns about deflation are also weighing on confidence in Europe.

    EY - Based on the current economic climate, please rate the health of the following business conditions?

    Fears about the rapidly expanding West African Ebola outbreak are also impacting companies’ operations in Africa, another high-growth region. A number of companies have imposed travel restrictions to countries such as Nigeria, which was, until recently, one of the world’s fastest-growing economies.

    Overall, Tom McGrath, Senior Vice Chair, Accounts for EY Americas, says that, although CFOs would usually factor in a certain amount of uncertainty, “there’s just more there today than perhaps there would be in a more normal environment.”

  • Strong corporate finances

    There is, however, a rather different picture when it comes to corporate performance. Some 71% of CFOs from the US see corporate earnings as strong, along with around one-third of respondents from Europe and Asia. “We do have some good, stable indicators in terms of company growth, growth in earnings, and the financial health of corporates,” says Ms Teigland.

    EY - What best describes your anticipated view of your firm's earnings per share growth in Q3 2014  compared to Q3  2013? (US respondents only)

    CFOs also see the cost of debt and credit availability as strong. Indeed, 77% of CFOs globally rate credit availability as strong, while 69% say the same about the cost of debt. They are also positive about stock market valuations and overall corporate earnings.

    So there seems to be something of a disconnect between strong corporate and financial-market performance on the one hand, and the underlying mixed health of the economy on the other. Ms Teigland cites Spain as just one example of this.

    “You see a continued and growing gap between what’s happening with the underlying economy—youth employment, consumer spending—versus the strong health of leading companies there.”

    Easy availability of credit and debt is clearly driven by continued ultra-loose monetary policy. This is also spilling over into record-high equity valuations, as investors shift allocations into risk assets in search of a return. Whether financial markets are yet in bubble territory is debatable, however, because of the strong performance of corporate earnings.

    “I think the fundamentals are there to support it,” says Mr McGrath. “It is obviously going to vary sector-by-sector and company-by-company but, on balance, I think the fundamentals are there. When you look at some of the forward-looking indicators on stock market valuation against projected earnings for next year, it’s not out of line with historical ranges.”

    The strong performance of corporate earnings reflects the considerable progress companies have made in recent years on imposing greater cost discipline. This has now become a permanent feature of the corporate environment, rather than one that is cyclical and will fade as the economy continues to recover.

    “For the past three or four years, corporations have spent a lot of time deleveraging, getting the fitness of the balance sheet in place, and really focusing on improving their operations,” argues Mr McGrath. “Even as growth returns, companies are likely to maintain rigorous cost-control.”

  • M&A revival

    The strength of corporate balance sheets and the ready availability of cheap credit, along with companies’ continued focus on achieving efficiencies and optimising their portfolios, has meant a revival of divestment and M&A activity. Almost half of CFOs see the tempo of M&A deal activity as above average.

    “The deal market clearly has come back,” says Tom McGrath in reference to the US. “It’s not as robust as it was pre-financial crisis, but we’re seeing growing volume. There is a tremendous amount of money in private equity and other private financing vehicles. We’re seeing more and more of that being put to work.”

    EY - How would you describe the current tempo of deal activity at your firm compared to the historical average?

    In Europe the picture is more mixed, with 43% of CFOs seeing M&A activity in their sector as strong, but an equal proportion viewing it as still weak. Current high totals for M&A values are driven mainly by a few high-value deals; for now, the volume of transactions has not increased significantly.

    But an upturn in activity is likely, thanks to a combination of a deflationary environment and tax policies that make it difficult for companies to leverage their strong balance sheets for shareholders.

    “What I do see is a lot more interest in evaluating and looking,” says Ms Teigland. “I wouldn’t say that they’re going through with the deal yet, but the appetite to look and to talk about it is clearly there. That was not the case two years ago, or even 12 months ago. That’s a positive sign.”

    One change from the pre-crisis period is that companies are making much more of a strategic assessment of where they want M&A deals to take them in terms of portfolio, rather than the more opportunistic approach that was often in evidence before the financial crisis.

    A more strategic approach to portfolio management is also likely to result in more spin-offs—Philips’ decision to divest its lighting division being one recent example. In the US, three in five CFOs say that their business has undertaken a portfolio review this year, and two in five say that they have spun off a non-core asset.

    “That trend has really been underway for the past few years, where a key aspect of the fitness of a corporation is whether the portfolio of the business makes sense,” says Mr McGrath. “Which units should be divested? So yes, they’re absolutely looking to get fit for purpose, and we think that trend’s going to continue.”

    EY - At any point this year, has your firm either considered or executed any of the following actions? (US respondents only)

    Top ten tips for effective portfolio management

    Leading companies focus on selling assets in the same rigorous way they focus on acquisitions – for many it’s a fundamental part of their strategy. Strategic divestments are key to raising capital and deploying it into a company’s core business.

    Selling assets and re-shaping portfolios can help you concentrate on higher-growth opportunities and create value for your stakeholders, if leading practices are applied to the process. Although selling can mean a short-term dip in top-line growth, redeploying and re-investing capital in core activities, expanding into new markets or developing new products can lead to longer-term growth and higher value.

    Read EY’s top ten tips for effective portfolio management

    Hear EY leaders explain what CFO's need to know about divestments

    As part of their attempts to leverage their strong balance sheets and ensure that they are in good shape for the new economic climate, companies are also investing heavily in IT. For CFOs globally, it is the top priority among their current capital expenditure priorities.

    “This is being driven by digital transformation, and by companies’ need to access big data and use it effectively,” says Mr Winter . “Improvements in companies’ ability to harness technology and big data are becoming a factor in the divergence between strong corporate performance and the still-mixed economic backdrop.”

    EY - Please rank in order of your current capital expenditure priorities

    Overall, then, the view of CFOs remains one of cautious optimism. The economic climate remains challenging and risks loom large, but companies have adapted and, with continued cost-control and strategic rebalancing, will be better placed to respond to uncertainty and volatility.