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As confidence plunges to all-time lows, CFOs prepare their companies for the worst.
Jason Karaian, CFO Europe Magazine
December 8, 2008
"This time is different" is the most expensive phrase in finance, according to European strategists at Morgan Stanley, who cite a long history of bursting bubbles in a recent report. Nonetheless, they add, "every now and then a true shift takes place."
Could this be one of those rare occasions? According to the latest poll of senior finance executives by CFO Europe, Tilburg University and Duke University, CFOs have never been as pessimistic as they are now. Previous regional variations virtually disappeared in the latest survey, with the share of economic pessimists among finance chiefs in Europe, Asia and the US setting all-time highs. Since the poll began more than ten years ago, the gap between pessimists and optimists has never been wider in any of the regions surveyed. (See charts at the end of this article. It should be noted that the data is preliminary, as final results were not available at the time of going to press.)
In response, companies are battening the hatches. In Europe, expectations for earnings, hiring and capital spending plunged in the fourth quarter. Profits are forecast to drop by more than 6% over the next year, compared with an increase of 5% forecast in the previous quarter. The size of domestic workforces is predicted to shrink by 6%, with foreign and outsourced workers — historically a strong area of growth among European corporates — predicted to fall by 2%. The outlook for capital spending is remarkably bleak, with finance chiefs in Europe looking to slash capex by 11% over the next 12 months, compared with predictions for modest growth in previous quarters.
Like skittish Christmas shoppers watching their purse strings, the fall in business investment is likely to bring about a serious recession, though whether the contraction will be short and sharp or long and painful remains open to debate. For their part, CFOs in Europe are evenly split as to whether a recovery will begin next year, or in 2010 and beyond.
Gary Clarke, head of European equities at Schroders, points out that corporate earnings in Europe fell, from peak to trough, between 35% and 40% during the previous four recessions. However, he adds, "when a financial crisis is combined with a recession, the recession has tended to be twice as long and twice as deep, and this is contributing to the uncertainty in identifying the bottom of the earnings trough."
As the Credit Crunches
What's more, the financial aspects of the current crisis are getting worse, according to CFOs. Around half of senior finance executives polled in Europe said that their companies were affected by the higher cost and lower availability of credit in the latest quarter's survey, up from one-third a year ago. (See "Freeze!" for more on the financial market crisis.)
On average, the cost of credit has risen by 106 basis points since last summer for companies in the survey sample, with some unlucky ones reporting borrowing costs exploding by up to 500 basis points. Fifty-six percent of CFOs said that credit had become scarce at any price. As a result, more of them are relying more on internal cash flow, asset sales and drawing down credit lines than in the past, making up for cutbacks in the use of commercial paper and convertible debt.
Despite major government interventions, three-quarters of CFOs in Europe remain concerned about the health of the financial institutions their companies deal with — 12% harbouring "significant" concerns. In their efforts to rescue many of these ailing institutions, some European governments are putting their own balance sheets under severe strain, perhaps contributing to the dim view of economic prospects.
Credit default swaps for UK sovereign debt recently traded at a wider spread than those for Lloyds TSB, a bank that has fared relatively well under the circumstances but is still operating in the most severe credit contraction in decades. In a similar vein, the spread on swaps for American sovereign debt recently eclipsed the spread tracking corporate bonds issued by fast-food chain McDonald's, a sign that maybe — just maybe — this downturn could develop into something even worse than in the past. "Our tactical indicators are still giving a buy signal," the Morgan Stanley strategists wrote, "but with such challenging fundamentals we prefer the risk-reward of cash."