Thursday, June 4, 2009

Duke CFO Survey Remains Downbeat; What Are Investors to Do?

While the news continues to flow, objectively the U. S. economy remains weak, as does every major economy in the world, with the possible exceptions of China and India. Chain store retail sales for May were reported today. Same-store sales were down substantially year-on-year, and were a bit below analysts' expectations (whatever that means), per the WSJ in U.S. Retailers Report Continued Weak Sales:

May same-store sales for retailers showed a much bigger-than-expected drop as the absence of rebate checks and continued reining in of consumer spending crimped buying. (Emph. added and Ed: When the tax rebate checks ceased last year, the economy and stock market started falling apart.)

Sales at stores open at least a year fell 4.8% for the 30 retailers that Thomson Reuters tracks, when a 4.1% decline was expected.

Many more retailers fell short of projections than in April. (Emph. added and Ed: Green shoots withering a bit?)

More important to EBR's readers is news you do not know. Earlier this week, the Gov't reported that year on year manufacturing wholesale business remains about 18% below last year's level. This may well be a bottoming process.

Duke University's Business School performs a CFO survey, excerpts from the results of which are reprinted herein. The press release is very long, so I have bolded the most important parts; reading them only is brief and suffices.

Not part of the press release are survey results for other parameters that they project for the next 12 months:

Salaries down 1%;
Change in prices of own firm's prices: up 0.3%;
Dividends (public firms only): down 12%.

Here's the press release (remember, you will do find reading the bolded parts only):

Global CFO Survey: 2009 Looks Dismal, but Longer Term Optimism Rebounds
Duke University Office of News & Communications


DURHAM, N.C. -– The worldwide recession will continue for the remainder of 2009, with substantial cuts planned in employment and capital spending, according to chief financial officers in the U.S., Asia and Europe. Many companies face severe credit constraints.

Yet, in spite of these near-term difficulties, CFOs in the United States and Asia are growing more optimistic about the longer-term economic outlook; European CFOs are not.

These are some of the findings of the most recent Duke University/CFO Magazine Global Business Outlook Survey. The survey, which concluded May 29, asked 1,309 CFOs from a broad range of global public and private companies about their expectations for the economy. (See end of release for survey methodology.) The research has been conducted for 53 consecutive quarters.

-- U.S. CFOs expect recession to last through 2009.
-- Fundamentals remain weak. Employment is expected to fall in both the U.S. and Europe (by approximately 5.5 percent) and the U.S. unemployment rate could reach into double-digits. In Asia, employment is expected to drop 1.4 percent over the next year.
-- Capital spending will decline by more than 10 percent in the U.S. and Europe and by 3 percent in Asia.
-- CFO optimism is rising from its recent all-time lows, with 54 percent of US and 63 percent of Asian CFOs more optimistic than they were last quarter. Only 30 percent of European CFOs are more optimistic and 31 percent are less optimistic. (See graph at bottom of release.)
-- Liquidity at lower-rated firms continues to worsen as they struggle to find credit. When they are able to secure credit, the cost is high.
Credit market conditions have stabilized at companies with strong credit ratings.
While the survey results indicate increasing optimism, the overall level of optimism is still low by historical standards.
"Our survey carries an important message: don’t put too much weight on the ‘soft’ data like consumer confidence. Recovery requires sustained confidence, and such confidence is forged by stronger economic fundamentals," said Campbell Harvey, founding director of the survey and international business professor at Duke’s Fuqua School of Business. "The economic fundamentals – employment, capital spending, the cost of credit – are still fundamentally troubling."
One example of underlying weakness is the surveyed companies’ employment plans. Employment in the U.S. is projected to decrease by about 5.5 percent over the next 12 months, which could drive the overall unemployment rate into the 11-12 percent range.
"Presumably, government programs will offset some of these losses, but even the most optimistic government forecasts would reduce the losses by only two million. We’re facing the possibility of another four million lost jobs," said Harvey.
The majority of U.S. and Asian CFOs have grown more optimistic about their respective national economies during the last quarter. On a scale of 0 to 100, U.S. CFOs rate the economic outlook at 52 (up from an all-time low of 40 last quarter), while Asian finance chiefs (not counting China) rate the economy at 63. Chinese CFOs gave the economy a 70, and Europeans only 47.
"The rest of 2009 will remain challenging, but 2010 looks better for the U.S. and Asia," said Kate O’Sullivan, senior writer at CFO Magazine. "The weak European outlook could dampen the recovery in the rest of the world. To put it in context, the U.S. rating of 52 is still well below the long-term average of 61, but it is heading in the right direction. Given the strong record of the CFO optimism index as a leading indicator, we can expect the U.S. economy to begin to recover by early 2010. But the CFO outlook for the rest of 2009 is fairly dismal."
CFOs expect earnings to fall at public U.S. companies by 4 percent over the next 12 months, down from expected earnings growth of 3 percent a year ago. Capital spending is expected to decline by more than 10 percent in Europe and the U.S. and by about 3 percent in Asia. Tech spending and research and development will fare somewhat better, declining slightly in the U.S. and Europe, and increasing slightly in Asia. Marketing and advertising spending is expected to drop by more than 6 percent in the West.
About six in 10 U.S. companies report they are credit constrained, meaning they have had difficulty locating credit, and/or the cost of available credit is much higher than before the
crisis. Among these constrained firms, 42 percent say credit market conditions have deteriorated during 2009, while only 23 percent say conditions have improved.
"There is a dramatic split between haves and have-nots in the credit market," said John Graham, a finance professor at The Fuqua School of Business and the director of the survey. "Companies that have remained profitable and retained high credit ratings are generally able to obtain new credit. In contrast, the companies that really need credit, because they are experiencing losses or have seen their cash reserves shrink, find worsening credit conditions. For these financially constrained companies, bank lines of credit have become more expensive to secure. These same firms are drawing more heavily on the credit lines they can obtain, rather than using them primarily for short-term needs as they would in normal conditions."
The big concern is we might hear the other shoe dropping, with the liquidity crisis that is strangling these companies creating substantial risk for the world economy."
The credit market bifurcation is evident in many ways. Constrained firms have seen the cash they hold on their balance sheets decline from 16 percent at the start of 2008 to 13 percent of total assets now, while unconstrained firms have seen their cash increase from 16 percent to 19 percent. Constrained firms have increased the amount drawn on their credit lines to 41 percent of maximum, while unconstrained companies have drawn only 24 percent of the maximum. For constrained firms, the interest rate premiums and fees they face are double those for unconstrained firms, and the number of months that banks are willing to commit to lending to them has declined. Two-thirds of constrained firms are required to provide collateral to secure a credit line.
Sixty percent of constrained companies report they have tried to negotiate more favorable terms with their lenders, but only one-third of these companies have been successful. One bright spot for these constrained companies is that about half have negotiated more favorable terms with suppliers. This does, of course, put strain on those suppliers.
Concerns about weak consumer demand and credit markets remain the top two external concerns for U.S. CFOs. They are also concerned about the policies of the federal government.
The top internal concerns are the inability to plan due to heightened economic uncertainty, working capital management and liquidity, and maintaining employee morale.
European CFOs say they do not expect economic recovery to begin in Europe for 12 months (compared to U.S. CFOs’ forecast of 10 months for the U.S.).
Forty-one percent of European CFOs say credit market conditions have worsened in 2009, compared to only 11 percent who say they have improved. Only one in four European firms has successfully renegotiated terms with lenders.
Nearly 60 percent of European companies have negotiated more favorable terms with suppliers, with lower prices or longer payment terms being the most common forms of easing.
Among European suppliers granting more favorable terms, nearly three-fourths say agreeing to more favorable terms is leading to financial stress at their firm.
Weak consumer demand is by far the biggest external concern among Asian CFOs, followed by credit market and currency risks. Liquidity and working capital management is a top internal concern in Asia. In China, the top internal concern is attracting and retaining skilled employees.
More than half of Asian CFOs report an increase in new orders this quarter, with the biggest increases coming from Southeast Asia, India and China. More than half of Chinese companies report an increase in orders from other Chinese companies.
Among Asian firms that are primarily suppliers to other firms, about two-thirds have granted more favorable terms to their customers. These concessions have come mainly in the form of lower prices (more than four in 10 cases) and longer payment schedules (about one in four cases). More than 80 percent of Asian suppliers report granting more favorable terms to their customers is putting financial strain on their own companies.

Here are some thoughts based on the above.

1. Drs. Roubini and Ken Rogoff are correct. So is David Rosenberg, ex-Merrill Lynch Chief Economist, now working in Canada. The economy is slow and will remain so for some time. By propping up numerous failing companies, the Fed and Feds may have laid the groundwork for a Japan-type scenario.
2. Risks abound, especially in the obvious sectors that have been the source of the major problems rather than the bystanders. Housing and finance are fragile. The more the markets push Treasury rates up, the more strain housing will be under, and the more the Fed will want to keep rates down, the actions of which will scare the markets more (or the markets will pretend to be scared as they may play a game of "chicken" with the Fed) and push rates higher.
3. In the 1930s, the strong companies got stronger as credit was unaffordable if it was available at all to small companies. This could be the case now.
4. The fears of inflation are probably premature. Commodities, however, are not the major source of inflation in the U. S.; wages are. So, commodities could continue to rise despite the absence of current net inflationary pressures.
5. As stated several times here, the authorities have seen to it that there are few if any sound investment alternatives. Thus, even though stocks have substantial downside before they would be considered cheap on an asset basis, shares of companies with the following characteristics can make sense for purchase during a year of continued depression but with the hurricane departing:

A. Dividend yield of at least 1% with likely dividend growth;
B. Plentiful access to capital;
C. International exposure if possible;
D. Not in a housing-credit (i.e. bubble)-related industry;
E. Positive free cash-flow generator;
F. Either a strong consolidator in an industry or a takeover target;
G. Strong but not ebullient short-term chart AND undamaged or strong long-term chart;
H. Price-earnings ratio below historical norms.

Specific names will be mentioned over the next days.

After an earthquake or hurricane hits, the structures in the region have been damaged. An aftershock or another storm may well hit; one wants to be an owner of securities that likely will survive a second hit.

Cash is still OK, as disinflation usually persists longer than expected after a severe deflationary event; and the more Treasuries sell off, the more potential they have for at least a strong bounce in price. Probably no major asset is more hated than the U. S. Government bond, yet the 30-year Govvie is right at its 200 year average while wage deflation has set in for the first time since the 1930s.

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