Uncertain climate hinders plans

Companies that are unable to quantify risks are holding back on investment, writes Brian Groom
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Lynn Krige, group finance director at Speedy Hire, the UK’s largest plant and equipment rental company, is grappling with an issue shared by her counterparts across British business: how bold to be in terms of expansion and investment in an environment fraught with risk and uncertainty.

“I am on the ‘caution, nothing heroic’ side,” she says. “For me it is about concentrating on the cost base and then, when the market does pick up, making sure we don’t take our foot off the [cost control] brake. That’s when we are really going to see the benefits.”

Much of corporate Britain is doing the same, which arguably creates a vicious circle for the economy. In the absence of consumer confidence, policymakers desperately need companies to lead the recovery by investing. But companies are reluctant to do so when they do not know when the downturn will end.

Viewed through a financial director’s eyes, the landscape is littered with risks: of not having access to funding when needed, of debts going bad, of sudden currency movements, of information technology failure, of supply chain disruption, or of exposure to a renewed recession or eurozone meltdown.

It is little wonder that many companies are building cash buffers against the unknown. The trick is learning to manage these risks without paralysing the business.

Speedy Hire, while exposed to the troubled construction sector, is not standing still. It will invest £50m this year, up by £20m on a couple of years ago, but this is careful investment in equipment for the more stable markets it is moving into, such as water, energy and transport infrastructure.

It is also expanding its international business serving oil and gas projects in the Middle East, which are worth 5 per cent of turnover. Last year Speedy Hire made its first annual profit since 2008.

Credit risk is among its biggest perils, to which it is paying close attention. Two years ago it had to write off £2m in debt when Connaught, the social housing maintenance group, collapsed.

“We budget at 2 per cent bad debt in any one year and we are running at 1.7 per cent,” Ms Krige says. “But if you have a big boy who goes down, that would blow that number out of the water.”

Guarding against credit risk means not only monitoring clients’ payment behaviour but also keeping an ear to the ground. Credit chasers in Speedy Hire’s service centre are in closer contact with depots to understand what is going on in customers’ businesses.

Steven Hall, a director in the risk consulting practice of KPMG, the business advisers, draws a distinction between risk and uncertainty: risk is something that can be quantified, allowing decisions to be made that balance it against likely returns; uncertainty prevents companies from putting a figure on it.

“For some organisations there is so much uncertainty at the moment that they are unable to really know where the full spectrum of risks are,” he says.

One of the ironies is that larger companies are starting to adopt many of the risk management techniques of the financial sector – the biggest spender in this area before the crisis – even though those techniques failed spectacularly.

Mr Hall has seen risk governance systems that typically are found in banks being used in the oil and gas industry, pharmaceuticals and beyond. They include three tiers of defence: the frontline managers who make decisions, a risk control function to devise policy frameworks for monitoring risks, and an internal audit function that looks at how the first two are operating in practice. Stress and scenario testing are also increasingly common. Another tool is for executives to establish an appropriate “risk appetite” for their business, which guides decisions.

But those who use such systems must learn from past mistakes, Mr Hall says. “There was an overreliance on modelling and quantification. People did not apply the human element to this and failed to realise that judgment is required as well.”

. . .

The purpose of risk management is to allow risks to be taken, not to prevent business being done. Those companies that are on top of their risks are the most able to seize opportunities to expand safely or to win market share.

Clive Lewis, head of enterprise at the Institute of Chartered Accountants in England and Wales, says some companies have been refinancing this year “because they know it could get more difficult next year”.

Others have been assessing how safe the banks they deal with are, and are shifting business into dollars or sterling rather than the euro, or trying to match assets with liabilities in countries that might leave the eurozone in case a sudden currency shift reduces their value.

Since the crisis began, the status of finance directors in businesses has risen, in unquoted companies as well as quoted ones, according to polling by the ICAEW. There is a heightened interest in financial management and better ways of optimising cash flow.

Big companies generally have sophisticated reporting systems, some of which give real-time information on what is happening as well as weekly or monthly reports. Processes are changing in smaller companies too.

“In smaller and medium-sized companies there is still scope for improvement, so the financial management systems generate information that can be used by the directors to monitor progress and change course where necessary,” Mr Lewis says.

Trevor Williams, chief economist for wholesale banking and markets at Lloyds Bank, does not blame companies for being prudent in hoarding cash so they are sure they can continue to operate amid all this uncertainty.

He adds, however: “It seems a good time to think about investing. After all, at this point of the cycle those companies that come out stronger tend to take pre-emptive and early action.”

Although the danger of a renewed downturn remains, Mr Williams says that “as the balance sheets of households and businesses are stronger than they were, we could be on the cusp of a significant recovery”.

When recovery comes, the strength of balance sheets should reduce the traditional danger of companies running out of cash when orders expand.

Good Energy, the first company to provide 100 per cent renewable electricity to UK households, is among those not put off entering a growth phase by the uncertain climate. “For us, it is a time for expansion and investment,” says Garry Peagam, finance director.

The company, which had a £22m annual turnover in 2011, raised £4m in equity by floating on the Alternative Investment Market in July.

It has been investing in trading systems and local weather information, so it can be competitive on price with the big six energy providers and achieve the right mix of wind, solar and hydro power. It also plans to boost its own generating capacity. “Our business is in an area that interests a lot of people,” Mr Peagam says. “If we can make it affordable and invest in the areas that make us competitive, we will be able to grow our business.”


Case study: Burton’s

Rising cereal prices after the worst US drought in more than half a century, coupled with the squeeze on consumers’ pockets, are risks on the mind of Jim Green, chief financial officer of the Burton’s Biscuit Company, the UK’s second-largest maker of biscuits by sales.

Private equity-owned Burton’s, whose brands include Jammie Dodgers, Maryland Cookies and Wagon Wheels, and which makes Cadbury biscuits under licence, is no stranger to financial risk.

The company is owned by Canadian Imperial Bank of Commerce and Apollo Global Management following a debt-for-equity swap in 2009 that saw Duke Street, which had struggled with the debt burden, hand over control.

After a number of deep cuts, including redundancies and a restructuring, the business is back in decent shape. Mr Green says it is “a time for caution”, but Burton’s is investing in developing and marketing its brands and growing overseas sales, which account for more than £40m of its £320m turnover.

“These are challenging times, but each year we invest a little more,” Mr Green says. “Food is a low or no-growth market place. Within that, there are opportunities to grow and you have to find them.”

With new variants such as Choccie Dodgers and Toffee Dodgers, the company is tapping into the market for “affordable treats”, which has helped it grow its UK market share from 7 per cent to 10 per cent over six years.

Mr Green says this helps it cope with commodity price inflation, which it also deals with by buying cereals, sugar and cocoa several months ahead.

“The [retail] trade can see that we are investing in its consumers and its market place,” he says. “You have to have the trade on your side when you go to it and say you need to put cost price increases through.”

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