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May 31, 2012 12:01 am
Politicians and economists have been pressing companies to start spending their cash piles, so an upturn in business investment reported in provisional data for the first quarter has come as a welcome relief for those who manage companies’ capital.
According to the UK’s Office for National Statistics, business investment – which had fallen sharply during the 2008-09 recession – rose by 3.6 per cent in the three months to March compared with the previous quarter, and by 14.2 per cent compared with a year ago.
It remains, however, more than 9 per cent below where it was in early 2008. With the UK economy in a double-dip recession and fresh instability in the eurozone, companies are bound to remain nervous about investment.
Businesses have been rebuilding their balance sheets, which, in many cases, were over-geared before the financial crisis. UK companies, excluding banks and financial institutions, have amassed £754bn in currency and deposits, equivalent to 50 per cent of gross domestic product, according to official figures. Not all of that may be available for investment in Britain – the biggest growth is in deposits held with foreign banks – but few doubt balance sheets are strong. Yet many companies have been unsure about when to start spending amid uncertain prospects.
“Business will always pause on investment if it thinks it is not going to get a return because the moment is wrong, because there isn’t enough consumer and customer demand,” says John Cridland, director-general of the CBI, the employers’ group.
Peter Spencer, chief economic adviser to the Ernst & Young Item Club, the non-governmental forecasting group, says the UK will not begin to prosper until these funds are put back into the economy. “Until these companies stop stashing the cash and start increasing levels of investment and dividends, the economy will remain on the critical list,” he warned last month.
Several large FTSE companies, including GlaxoSmithKline and AstraZeneca, the pharmaceutical groups, and BP, the energy company, have denied they are sitting unnecessarily on cash piles.
BP says it is investing more in the UK now than in recent years, with £4bn committed to various offshore projects over the next five years.
Carmakers have pledged substantial investment, helped by demand in emerging markets and a flexible workforce. General Motors’ £125m investment in its new Astra at Ellesmere Port on Merseyside comes on top of £4bn of commitments from Jaguar Land Rover, Ford, BMW, Bentley and Toyota.
InterContinental Hotels, Subway, McDonald’s, Starbucks and Marston’s are among leisure chains planning expansions that will create thousands of jobs. National Grid aims to spend £31bn by 2021 upgrading Britain’s gas and electricity networks.
Companies that invest when others do not can prime themselves for future expansion and steal market share from rivals, provided they do so wisely.
Some are investing with the help of the government’s £2.4bn Regional Growth Fund, such as Darchem, an engineering business based at Stillington, near Stockton-on-Tees. It is awaiting confirmation from its US parent of an £8m investment to create production facilities for specialist fabrication for the new-build nuclear market, towards which the fund has offered £1m.
Graham Payne, managing director, admits uncertainty over the government’s nuclear power station plans is a “big worry”, but says the proposed investment is not a risk. Darchem does other nuclear work including insulation and could use the plant for aerospace manufacturing, too.
Two-thirds of its work is in aerospace, but Mr Payne says the nuclear sector will be “one of the most fundamental parts of our future growth in the next five to 10 years”.
. . .
Many companies, though, have been holding back on investment decisions until they see more light at the end of the tunnel. “Are they being cautious? Yes. Are they being irrational? Probably not,” says Lee Hopley, chief economist at EEF, the manufacturers’ organisation.
Richard Jeffrey, chief investment officer at Cazenove Capital Management, says the rebuilding of balance sheets is a hangover from the credit crisis, when companies conserved cash because they feared they would be denied access to credit. “This is where they want their balance sheets to be,” he says. “They want to have more liquid assets; they want more cash because that is what provides them with reassurance.”
He hopes to see “more significant growth” in investment over the next two years than in 2011, when it grew by just 1.2 per cent, but warns that when companies spend, they may be tempted to invest in higher-growth economies rather than in the UK.
Mr Jeffrey says that when investment comes, some companies may be doing it from a position of weakness. “It will be interesting to see what Tesco [the supermarket group] does, for instance. I suspect that when they decide what their future is going to be, it will require some investment.”
He also warns that if companies hang on to their cash piles for too long, the government may try to take them away. “If companies continue to grow their share of national income, there is going to be a temptation for government – not just ours but governments in general – to say we should be taxing these companies more heavily.”
Philip Booth, editorial director at the Institute of Economic Affairs, says: “If I were a shareholder I would be asking directors why they were sitting on cash that they could return to shareholders – why are we not paying dividends? It’s not a company’s job to sit on piles of cash.”
He agrees, however, that it is rational for companies, particularly smaller ones, to build up cash piles for future investment because of fear that higher capital requirements on banks will make it even harder to get credit.
Prof Booth calls for microeconomic measures to help companies, particularly by further radical deregulation of the labour market and relieving companies of the impending burden of auto-enrolment of their staff in pension schemes such as the National Employment Savings Trust, the low-cost scheme created by the government.
Strategists say that even if the eurozone crisis provokes a renewed economic downturn, companies should have an eye to opportunities as well as simply cutting costs. Research by PA Consulting Group suggests that, in the recession of 2008-09, companies that saw the crisis as an opportunity to acquire assets cheaply or win market share from weakened rivals achieved a 10 per cent higher total shareholder return than those that did not.
Mark Thomas, business strategy expert at PA, believes companies are poorly prepared for the consequences of a Greek exit from the euro. “It is a difficult business to plan for, but I think you need to do some planning – maybe a central scenario where things are not so disorderly, and also an extreme one.”
With or without a eurozone apocalypse, some companies see clear virtues in investment even in difficult times. “We have been investing while others have been tightening their belts,” says Majid Hussain, managing director of Accrol Papers, a maker of kitchen and toilet rolls, based in Blackburn, Lancashire.
After spending £25m on machines and buildings since 2005, allowing it to make high-quality paper more cheaply, Accrol plans a further £30m investment in the next two years. Mr Hussain adds: “Perhaps it’s a bit high risk to be investing in a recession period, but for us it’s been paying off.”
Additional reporting by Chris Tighe
Case study: Center Parcs
Martin Dalby, chief executive of Center Parcs, needs no reminding of the value of investment.
“One of the reasons we have been successful for the past 25 years is we are forever reinvesting the profits and refreshing the product,” he says.
The holiday operator has begun construction on a £250m village – the company’s fifth – on the Duke of Bedford’s Woburn estate, north of London, buoyed by strong trading and a 97 per cent occupancy rate at its four existing sites.
This was no sudden decision. Mr Dalby first walked through the greenbelt forest site eight years ago. A battle against local opponents ensued before planning permission was granted in September 2007, after initial rejection.
Since then, the company has been diverting footpaths and bridleways and building new roundabouts. It also took a year to put together finance, of which £100m will come from Blackstone, the group’s private equity owner, and £150m in a construction loan from RBS, Barclays, HSBC and Lloyds Banking Group.
Unlike some companies, Center Parcs did not have a cash pile. The trigger for the Woburn funding was refinancing of its £1bn debt, which had been due to expire next year. It has been replaced by a bond issued via a “whole business securitisation” backed by revenue from its existing villages in Cumbria, Nottinghamshire, Suffolk and Wiltshire.
The Woburn Forest site, due to open in spring 2014, will employ 1,200 people in the construction stage and 1,500 once it opens.
Mr Dalby has little doubt that there will be sufficient demand even if economic growth remains slow.
Center Parcs, which attracts families, has so far seemed recession-proof: if money is tight, many trade down to the short-break holidays at which it excels.
Mr Dalby expects the investment to add 20 per cent to Center Parcs’ turnover and 25 per cent to its profits. In the year to April 2011, it had earnings before tax, depreciation and amortisation of £131m on revenues of £290.5m.
This will probably be its last site in the UK, where it views its geographical coverage as complete.
Ireland remains a strong candidate for expansion abroad, though Center Parcs ended talks with the government in Dublin two years ago after the recession hit. In the long term, Center Parcs is eyeing markets such as India and China.
In the six years since Blackstone bought Center Parcs, it has spent more than £250m upgrading the existing villages and will spend a further £60m over the next three years.
Mr Dalby says 60 per cent of customers come back every three years, so it is important to attract them with well-maintained facilities and new restaurants and leisure attractions.
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