Outlook For Corporates 2013

By M. Isi Eromosele

2013 will be an interesting test of nerve for corporates, both the executives that run them and the institutions that invest in them.

The financial markets and developed economies are clearly in a fragile state with numerous situations, particularly the Eurozone crisis, capable of delivering sharp shocks to market confidence.

If the Eurozone situation deteriorates, there could be severe disruptions to multiple areas of the global market with capital becoming harder to raise, counterparty credit risk increasing, commodity prices falling and large parts of the developed world slipping into recession.

But if the situation stabilizes or improves, there could be very favorable conditions indeed for corporates with growth returning to the U.S., Europe shrugging off recession, share prices rising, falling credit spreading and the return of liquidity to the capital markets.

The vast gulf between these two scenarios makes the strategic choices taken by corporates in 2013 especially important. The two key questions for corporates, as always, are how to employ capital (if they have it) and how to raise it (if they don’t).

The choice in the former is between growth (expanding capacity and/or making an acquisition) and consolidation or defensive strategies (buying back shares and initiating or increasing dividends).

Buying back shares certainly appears attractive whatever the economic conditions. U.S. equities are currently trading at their lowest multiples since March 2009 and are now, in the opinion of our equity strategists, 30 percent below fair value.

Dividend increases seem more suited to negative economic scenarios. In a rising market, they will not significantly enhance share prices. In a weak or falling market, with investors focusing on income rather than capital growth, it could have significant benefits.

The choice between organic capacity expansion and mergers & acquisitions is, perhaps, the most intriguing. In some sectors, growing earnings significantly through organic growth alone may be challenging.

The pharmaceuticals industry, for example, appears to have hit a ceiling in the area of new drug development with slow progress on new drug approvals making it hard to maintain returns on research and development above the cost of capital. Here, the focus is likely to be on mergers & acquisitions.

Prospects for M&A activity generally look strong. According to Deutsche Bank’s 'M&A affordability index' which looks at debt financing costs, growth expectations and other variables, the conditions for M&A are now the strongest in recent history

In others, the case for capacity expansion is compelling. Investment in cloud computing technologies and services, for example, looks set to increase by 19 percent in 2013 with large technology vendors like IBM expected to spend over $50 billion on new infrastructure in the next three years.

Emerging markets continue to offer significant opportunities with Africa emerging as a region with particular potential.

Expect to see large cap companies continuing to spin off non-core assets and using the proceeds to increase their operations in Asia.

In financing, the outlook for 2013 is broadly positive. Demand for non-financial investment grade corporate bonds is strong (partly because of investor concern about the banking sector), and interest in high yield paper has picked up significantly in recent months.

This suggests that many companies will be able to raise large amounts of debt in the public bond markets in 2013 at extremely competitive rates of interest.

The outlook for equity issuance is also positive, providing there is some stabilization in the macro-economic and market climate.

However, it seems likely that there will be some periods of instability in both equities and bonds when (because of macro events) the markets close to certain issuers, just as they did in 2012.

Given this, it would seem prudent for corporates to raise as much as they can, as early as they can in the year to protect themselves against prolonged market closures.

An interesting alternative to public equity issuance are private funds such as sovereign wealth funds and private equity funds, many of which are actively looking to take strategic stakes in selected corporates.

Another key area that corporates will need to focus on is risk management. During 2012, there were some very severe, sudden swings in both commodity prices and exchange rates. This increased the cost of hedging using plain vanilla products and made multi-asset hedges more attractive. Expect this to continue in 2013.

Corporates will also need to address multiple issues in pension liabilities. Estimates for the funding gap for U.S. corporates range from $400 to $500 billion depending on discount rate assumptions. Studies indicate that for each 1 percent decline in rates, these liabilities will increase by between 10 percent  to 15 percent.

Corporates that are able to understand and monitor these risks and have the systems, staff and infrastructure to identify appropriate hedges will outperform.

The uncertain regulatory outlook for hedging products such as interest rate swaps and FX options is a further complication where there will be greater clarity later in the year.

All in all, 2013 will be a challenging but potentially very exciting year ahead.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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