Deloitte Q2 Cfo Survey

The Deloitte CFO Survey No return to business as usual

2009 Q2 Results 14 July 2009

Contents The Deloitte CFO Survey: Conclusions

1

Recovery in sight?

3

No return to boom

4

Deleveraging ahead

5

Optimism on M&A

6

Equity is back

7

Data archive

8

This is the eighth quarterly survey of Chief Financial Officers and Group Finance Directors of major UK companies. The 2009 second quarter survey took place between 12 and 26 June. 117 CFOs participated including CFOs of 29 FTSE 100 and 39 FTSE 250 companies. The remaining respondents were CFOs of other FTSE companies, large private companies and UK subsidiaries of major companies listed overseas. The combined market value of the 83 UK listed companies surveyed is £396 billion, or approximately 30% 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. For copies of earlier CFO Surveys see www.deloitte.co.uk/cfosurvey

The Deloitte CFO Survey: Conclusions No return to business as usual Key points from the 2009 Q2 Survey • Optimism about the financial prospects of the UK corporate sector has risen to the highest level in two years. • Most CFOs expect the UK economy to recover in 2010. • Credit conditions have improved for the second consecutive quarter but they remain tough and CFOs expect this to persist well into the recovery. • CFOs are increasingly looking to equity and bond markets for finance. • The environment for business is expected to remain very difficult well into the recovery. • GDP growth is expected to be sluggish and unemployment is expected to rise for at least a year into the recovery. • CFOs believe the upturn will be marked by tight credit conditions and high levels of risk aversion. • Corporates are likely to react to these conditions by reducing debt levels and cutting costs. • Sentiment about issuing debt or equity improved sharply in June, taking it to the highest level since the Survey started in 2007. • Equity is now seen as a far more attractive form of finance for corporates than bank borrowing, a reversal of the situation in 2007 and 2008. • CFOs are positive about the outlook for mergers and acquisition activity. Sentiment about M&A and private equity activity has reached the highest level in two years.

The first quarter 2009 CFO Survey, released in April, reported “glimmers of hope” in the economy and was one of the earliest indicators to suggest that the economy had, perhaps, troughed. Our latest survey, carried out in June, shows that CFO optimism continued to strengthen in the second quarter. We also found a clear, though not universal, conviction among CFOs that the UK economy will recover during next year. But, while for most the end of the recession is in sight, CFOs see further problems ahead. This quarter’s special questions reveal that UK CFOs expect the recovery to be marked by sluggish growth, a strong focus on cost control and tight lending conditions – hardly a return to “business as usual”. Recovery: good news, bad news In June CFO sentiment about prospects for their own companies saw the biggest ever increase, taking it to the highest level since the CFO Survey started two years ago. Most CFOs now expect a recovery to unfold in 2010, although a substantial minority, 23%, do not expect a return to growth until 2011 or later. Expectations for M&A, perhaps the most cyclical element in corporate expectations, have risen very sharply. 83% of CFOs expect M&A to rise over the next year. While sentiment has strengthened, perhaps reflecting an improvement in credit conditions, CFOs do not expect a quick upturn in demand for their own products and services. Most, some 59%, see no revival in demand for at least a year. Moreover, one of our special questions this quarter shows that an overwhelming majority of CFOs expect the environment for business to remain very difficult through the first year of any recovery. Most CFOs think the upturn will be sluggish and credit conditions will remain tight. Such expectations help explain why most CFOs expect corporates to reduce debt levels and to maintain a strong focus on cost control as the economy recovers. With CFOs assuming that growth will be weak and cost reduction a priority it is, perhaps, unsurprising that 85% of CFOs think unemployment will rise through at least the first year of the recovery.

The Deloitte CFO Survey No return to business as usual

1

Deleveraging ahead In June CFOs reported a further improvement in credit conditions, taking them back to levels prevailing before last September’s collapse of Lehman. This marks a significant improvement, and it suggests that government action to stabilise the financial system is having an effect. Nonetheless, the overwhelming majority of CFOs still rate credit as being scarce and expensive. Nor are UK corporates counting on a return to the easy credit conditions that preceded the financial crisis. Indeed, CFOs’ expectations that lending terms will remain tight and credit availability reduced is fully consistent with the experience in previous financial cycles. Past financial crises have generally triggered a long process of deleveraging across the economy, something which continues even as growth recovers. The drive by consumers and corporates to reduce debt levels reflects an unwinding of credit boom excesses and a desire to strengthen balance sheets. In addition, the private sector almost always has to contend with much reduced credit as banks themselves de-risk and de-leverage their balance sheets. CFOs assume these patterns will repeat in this cycle. Some 80% of CFOs expect deleveraging to continue through the recovery. The proportion of CFOs planning to reduce gearing in their own companies over the next year outnumbers those planning to increase it by two to one.

One little noticed aspect of the recession has been the sharp decline in corporate demand for bank financing recorded by the Bank of England’s Credit Conditions Survey. The Bank’s latest survey shows that credit demand from corporates is declining more slowly. But CFOs have become increasingly sceptical about bank finance as a source of capital for their business through the recession. Yet if the banking system proves unable or unwilling to meet the requirements of the corporate sector for capital, where can corporates turn? The CFO Survey shows that CFOs are increasingly looking towards equity and bond markets for finance. CFO sentiment about issuing equity and corporate bonds saw the biggest ever increase in June, taking it to the highest level since the Survey started in 2007. Equity has emerged as the most popular form of finance among CFOs and bank borrowing as the least popular, a reversal of the situation in 2007 and 2008. This combination of reduced debt levels and rising equity issuance suggests that at least the early phase of the recovery will be marked by falling corporate gearing in the UK.

Contacts Margaret Ewing Partner and Vice Chairman 020 7303 3323 [email protected] Ian Stewart Chief Economist 020 7007 9386 [email protected]

For additional copies of this report please contact Matt Gentle on 020 7303 0294 or email [email protected]

2

Recovery in sight?

In June CFO sentiment saw the biggest ever increase, taking it to the highest level since the CFO Survey started two years ago.

Chart 1. Financial prospects Net % of CFOs who are more optimistic about financial prospects for their company now than three months ago More optimistic

CFOs have become much more optimistic about the financial prospects of their own companies.

30% 20%

22%

10% 0% -10%

Less optimistic

-19%

-24%

-20%

Most CFOs, 73%, now expect the UK economy to recover during 2010.

-9%

-4%

-30%

-30% -40% -53%

-50% -60%

-59% 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

Chart 2. CFOs’ views on the timing of the recovery % of CFOs expecting a recovery in each period

But a substantial minority, 23%, do not expect a return to growth until 2011 or later.

4% 23%

73%

Recovery later this year

CFOs’ views on the outlook broadly fit with those of economists. After a huge downside shock to growth expectations over the last year, economists now expect the UK to see a weak recovery in 2010.

Recovery in the course of 2010

Chart 3. Consensus forecasts for UK GDP growth Evolution of consensus/average growth forecasts for the UK economy 4 2007

3

The average economist sees the UK economy growing by 0.6% in 2010 following an expected 3.7% contraction in GDP this year. This profile is consistent with a resumption of quarterly growth later this year. Economists have had to downgrade their growth forecasts substantially in the last two years but in June GDP forecasts for 2010 have edged up slightly.

No recovery until 2011 or later

2 2008

1

2010

0 -1 -2 -3 -4 Mar 06

2009 Sep 06

Mar 07

Sep 07

Mar 08

Sep 08

Mar 09

Source: The Economist

The Deloitte CFO Survey No return to business as usual

3

No return to boom While CFOs think that the economy will recover, they remain cautious about a revival in demand for their own firms’ products and services. Most, some 59%, see no revival in demand for at least another year.

Chart 4. When will growth in demand accelerate? % of CFOs who expect growth in demand for their company’s products and services to accelerate by 40% 39% 35% 30% 25%

25%

20% 15%

16% 12%

10% 5% 0%

CFOs believe that conditions for corporates will remain difficult even as the economy recovers. The first year of the recovery is expected to be very different from the last years of the boom. There is no expectation of a return to “business as usual”.

4% 2009 H1

4% 2009 H2

2010 H1

2010 H2

2011

2012 or beyond

Chart 5. Beyond the recession % of CFOs who think corporates will face the following factors for a year or more beyond the end of the recession

95%

Strong focus on cost control

Most CFOs think that the recovery will be marked by sluggish GDP growth and a strong focus on cost control by corporates. Risk aversion is expected to remain high among corporates and 85% of CFOs believe unemployment will rise for at least a year into the recovery. 80% of CFOs believe corporates will continue to reduce debt levels, and a majority expect credit to remain in short supply and credit conditions to remain tight. CFOs clearly do not expect that the end of the recession will herald an end to the problems of the corporate sector.

Sluggish GDP growth

91%

Tighter lending terms from banks

90%

85%

Rising unemployment

Deleveraging

80%

Elevated levels of risk aversion

79%

69%

Significantly reduced availability of credit

63%

Elevated levels of financial market volatility

41%

Falling house prices

0%

4

20%

40%

60%

80%

100%

Deleveraging ahead While financial conditions have improved in recent months, one of the underlying causes of the crisis, excess debt, remains. This explains the widespread expectation that a process of deleveraging lies ahead, particularly for financial institutions and households.

Chart 6. Debt levels Ratio of debt to GDP among selected advanced economies (in percent, GDP-weighted, 1987=100) 300 Financial institutions

250 200

Households 150

Corporates Government

100 50 1987

1990

1993

1996

1999

2002

2005

2008

Source: IMF Global Financial Stability Report, April 2009

History suggests that credit conditions are likely to remain tough for some time. The Japanese and Swedish financial crises of the 1990s were marked by several years of debt reduction. The IMF expects that lending by banks in the major industrial economies will continue to contract for at least a further year.

Chart 7. Financial crises trigger deleveraging Bank credit to the private sector in Sweden and Japan before and after their crises (percent of nominal GDP) 140 Sweden (Peak – 1992)

130 120 110 100

Japan (Peak – 1993)

90 80 70

-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 Years before

Peak

1

2

3

4

5

6

7

8

9 10 11 12 13 14 15

Years after

Source: IMF Global Financial Stability Report, April 2009

Certainly debt is out of favour with UK CFOs, albeit slightly less so than last quarter.

Chart 8. Leverage Net % of CFOs who think UK corporate balance sheets are overleveraged

50% of CFOs believe that UK corporate balance sheets are overleveraged and 5% underleveraged, giving a net balance shown in the chart of 45%. 

60%

50% 45%

Over leveraged

40%

Under leveraged

Almost half of the CFOs polled plan to reduce gearing in their own companies over the next year.

60%

35%

30% 24%

20%

27%

6%

10% 0% -10% -20% -30%

-17% -27% 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

The Deloitte CFO Survey No return to business as usual

5

Optimism on M&A Chart 9. M&A and PE outlook Net % of respondents who expect M&A and PE activity to increase in the next 12 months 100%

81

80% Will increase

60%

42

40%

22

20%

Will decrease

0% -20%

-80%

-44 -61

-67

-72

2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

100%

The latest survey shows that banks have increased credit availability, a finding that cross-checks with the CFO Survey. Credit demand is contracting more slowly, but the CFO Survey suggests that corporates have become more sceptical of the merit of bank financing.

100%

80%

60%

40%

40%

20%

20%

0%

0%

-20%

-20%

-40%

-40%

-60%

-60%

Availability of credit (rhs)

-80%

-80% 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

-100%

Chart 11. Credit demand/supply: UK banks’ views 20 Bank credit available to corporates

10 0 -10 -20 -30 -40

Demand for credit from corporates

-50 -60

Jun 07

Sep 07

Dec 07

Mar 08

Jun 08

Source: Bank of England Credit Conditions Survey

6

80%

Cost of credit (lhs)

60%

-100%

It is useful to contrast CFOs’ financial attitudes with banks’ views as measured by the Bank of England’s Credit Conditions Survey.

PE activity

Net % of respondents reporting credit is costly and credit is easily available

Credit is costly

Those trends have partially reversed since the start of the year. Credit conditions remain tough, but they are better than in the aftermath of the failure of Lehman last autumn.

-27

Chart 10. Cost and availability of credit

Credit is cheap

2007 and 2008 saw a major deterioration in the cost and availability of credit to corporates.

-5

-9

-50

M&A activity

This chart provides perhaps the most graphic illustration of the evolution of the credit crunch over the last two years.

13

-22

-40% -60%

19

16

1

Credit is available

This quarter saw the biggest ever increase in CFO optimism on M&A, taking it to the highest level since the survey started in September 2007. Sentiment about private equity activity has also turned positive for the first time in two years.

Credit is hard to get

CFOs have become increasingly bullish on M&A activity, a development that fits with an improved economic outlook and still-depressed asset valuations.

Sep 08

Dec 08

Mar 09

Jun 09

Equity is back The credit crisis has triggered a shift in CFOs’ preferences for sources of financing for their businesses.

Chart 12. Favoured source of corporate funding Net % of respondents reporting the following sources of funding as attractive

In 2007, before the crisis really hit, CFOs had a strong preference for bank borrowing and an antipathy to equity finance. Attractive Unattractive

But this year bank borrowing has moved out of favour and equity has emerged as the most popular form of finance. In June corporate bond issuance moved ahead of bank borrowing in terms of popularity for the first time since the Survey started.

60% 40% 20%

-20% -40%

Bond issuance 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

Chart 13. Good time to issue debt/equity?

Good time

Net % of respondents who think now is a good time to issue debt/equity 20% 3 0% Not a good time

CFO sentiment about issuing debt and equity saw the biggest ever improvement in June taking it to the highest level since the Survey started.

Equity issuance

0%

-60%

CFOs have become less enthusiastic about bank financing and are increasingly looking to the bond and equity markets for capital.

Bank borrowing

-20% -33

-40% -49 -60% -69 -69

-63

-64

-71

-75

-80% -88 -100%

-92 -90

-84

2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 Equity

The 2009 Q1 Survey showed that CFOs believe that in future corporates are likely to rely more on equity finance and less on debt finance. The second quarter Survey confirms CFOs are increasingly willing to contemplate issuing equity.

-80

-76

-76

Debt

Chart 14. Source of funding Net equity issuance by UK corporates vs net bank borrowing 12 month moving average (in £m) 8,000 7,000 6,000

Official data show that a major change is already underway. Net bank borrowing has collapsed in the UK in the last year, while net equity issuance has turned positive after several years of declining issuance.

5,000 4,000

Net bank borrowing

3,000 2,000 1,000 0

Net equity issuance

-1,000 -2,000 2004

2005

2006

2007

2008

2009

Source: Bank of England

The Deloitte CFO Survey No return to business as usual

7

Data archive A note on methodology Many of the charts in the Deloitte CFO Survey show the results in the form of a net balance. This is the percentage of respondents reporting, for instance, that bank credit is attractive less the percentage saying bank credit is unattractive. This is a standard way of presenting survey data used by, amongst others, the CBI and the European Commission. To aid interpretation of the results, this table contains a full breakdown of responses to most of the regular questions covered in the CFO Survey. Due to rounding answers may not sum to 100. Q3 2007 %

Q4 2007 %

Q1 2008 %

Q2 2008 %

Q3 2008 %

Q4 2008 %

Q1 2009 %

Q2 2009 %

How would you rate the overall availability of new credit for corporates? Available 42 26 Neutral 10 19 Hard to get 48 55 Net balance -6 -29

31 6 63 -31

16 7 77 -61

5 6 89 -84

1 0 99 -98

2 4 94 -92

13 15 72 -59

How would you rate the overall cost of new credit for corporates? Costly 59 Neutral 22 Cheap 20 Net balance 39

64 26 10 55

72 25 3 69

89 10 1 88

97 2 1 96

95 4 1 94

86 11 3 83

82 15 3 79

Bank borrowing, as a source of funding, is  Attractive Neither attractive nor unattractive Unattractive Net balance

73 12 16 57

44 28 28 16

59 16 25 34

47 13 40 7

35 14 51 -16

29 9 62 -33

27 12 61 -34

27 22 50 -23

Corporate bonds, as a source of funding, are Attractive Neither attractive nor unattractive Unattractive Net balance

55 18 27 27

33 33 33 0

28 19 53 -25

40 29 31 8

14 17 68 -54

20 14 66 -46

22 23 55 -33

35 32 34 1

Equity raising, as a source of funding, is  Attractive Neither attractive nor unattractive Unattractive Net balance

26 24 50 -24

19 33 48 -29

19 9 72 -53

29 20 51 -22

17 24 58 -41

21 13 66 -45

27 28 45 -18

44 26 30 14

UK corporate balance sheets are Overleveraged Appropriately leveraged Underleveraged Net balance

4 65 31 -27

5 73 22 -17

13 81 6 6

32 61 7 24

33 61 6 27

38 59 3 35

63 34 3 60

50 44 5 45

Cash return to shareholder ratios (including share buybacks) are  High 41 Normal 49 Low 10 Net balance 31

35 60 5 30

32 52 16 16

17 56 27 -10

15 39 45 -30

25 26 49 -24

15 13 72 -57

9 22 68 -59

In a year’s time, FTSE 100 will be  Higher Broadly unchanged Lower Net balance

45 33 22 24

30 40 30 0

50 25 25 25

40 33 28 12

49 35 16 33

66 26 8 58

65 23 12 53

62 34 4 58

14 12 75 -61

21 14 65 -44

31 16 53 -22

38 26 37 1

48 27 26 22

40 36 24 16

56 29 15 41

83 15 2 81

Volume of acquisitions by private equity in the quoted equity market will Increase 14 12 No change 6 5 Decline 80 84 Net balance -67 -72

22 6 72 -50

32 23 45 -13

31 30 39 -8

20 33 47 -27

29 37 34 -5

40 40 21 19

Compared with three months ago how do you feel about the financial prospects for your company?  More optimistic 26 17 22 17 Unchanged 44 43 47 47 Less optimistic 30 40 31 36 Net balance -4 -24 -9 -19

3 41 56 -53

7 27 66 -59

15 40 45 -30

37 49 15 22

Levels of M&A in the UK will  Increase No change Decline Net balance

8

Equity has emerged as the most popular form of finance among CFOs and bank borrowing as the least popular, a reversal of the situation in 2007 and 2008.

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