CFOs unnerved by prospect of Brexit and minority government

Confidence among UK CFOs has tumbled, largely as a result of the latest election result. Companies are increasingly worried about the effect of Brexit and weak demand will have on their operations, while many are opting to reduce investment and begin cost cutting.

The 40th quarterly Deloitte CFO Survey saw Chief Financial Officers and Group Finance Directors of major companies in the UK mark out the “omnishambles” of the nation’s snap general election as delivering a sharp drop in optimism, following a period of growing positivity among business leaders about the effects of Brexit on the long-term prospects of the UK economy. Now, a sudden sense of the reality of what Brexit could mean for the UK with an unpopular government with a questionable mandate at the negotiating table, appears to be rattling the confidence of CFOs.

The survey saw 122 CFOs participate, including the CFOs of 22 FTSE 100 and 54 FTSE 250 companies, between the 12th and 27th June. The remainder of respondents included CFOs of other UK-listed companies, large private companies and UK subsidiaries of major companies listed overseas. The combined market value of the 92 UK-listed companies surveyed is £509 billion, or approximately 20% of the UK quoted equity market.

While the lack of an overall majority for the Conservative government boosts the likelihood of a closer long-term working relationship between the UK and the EU, the election result, and the increased pressure placed on the UK to provide a coherent strategy going into the negotiations – has prompted key business in the UK to sign a letter, urging the government to consider a softer option for Brexit – citing immigration and market access as key areas of importance to business.

Since the end of Q2 in 2016, CFOs were becoming increasingly optimistic that the result of Brexit might not be as bad as predicted, with 19% saying in Q1 2017, that they would be better off if the UK leaves the EU. This has, however, changed significantly in the most recent quarter, with a drop of 11% noted to the ‘better off‘ category, to 8%, while 72% said that they would be worse off, up from 60% in the previous quarter.

The drop in confidence about the UK’s business community to thrive post-Brexit is further reflected in the overall business optimism of respondents, which has fallen sharply since Q1 2017. The fall, of around 35 percentage points, from a +15% net result among CFOs to a net -22% result, is still well above the most negative result in recent reporting, which immediately followed the Brexit referendum. However, the fact that those rates are higher than that nose-diving -70% net confidence vote, will give little comfort to those charged with implemented the UK’s divorce from the EU.

Remarking on the sharp decrease in confidence, Ian Stewart, Chief Economist at Deloitte, said, “This latest dip likely reflects the surprise outcome of the election, so a drop in confidence is understandable. CFOs are also more focused on the prospect of slower UK growth. What is striking from this survey is that concerns around geopolitics and weak global growth, which dominated CFOs’ concerns in 2015 and 2016, have eased significantly.

He went on to say, “This survey ran at a point of high political uncertainty and it is worth noting that sentiment and risk appetite are still well above the levels seen last summer. Favourable financial conditions and an improving global backdrop are also helping to support business at a time of rising domestic uncertainties."

The decrease in confidence translates into a mixed-bag result for four key industry indicators, presided, in part, over by CFOs – with the result largely negative.

In terms of M&A, which has already been on hold in the UK in recent quarters, around 17% say activity in the sector will decrease in the coming period. Capital expenditure too is seeing a likelihood of decreased activity, as cited by 33% of respondents, up from 26% in the previous quarter. Hiring activity is found to have been negatively affected by negotiations so far and the election result, falling to 38% of respondents. Discretionary spending sentiment is up slightly, from 50% to 49% saying that investment is set to decrease.

The research suggests that Brexit looms large in perceived risks to business, with its effects averaging 60 on a weighted scale between 0 (no risk) and 100 (existential risk), up from 55 points in the previous quarter. Weak demand in the UK too is increasingly seen as a risk, up from 51 points in the previous quarter to 57 points on the same scale. Linked to this, the prospect of higher interest rates and a general tightening of monetary conditions in the UK and US, continues to hover at 50 points, as stagnating wages in particular threaten to cause consumers to further scale back on their spending, causing demand to fall.

Some areas have seen general improvement however, such as the risks associated with a ‘bubble in housing and/or other real and financial assets and the risk of higher inflation’, while risks associated with protectionism in the US on the UK have abated somewhat, from 47 points to 45. The biggest decrease was noted in ‘weakness and/or volatility in emerging markets and rising geopolitical risks in the Middle East/Ukraine’, which fell from 35 points to 32 points.

Sensitive to risk

In the face of risks from Brexit, among other items on the plates of CFOs, the respondents to the survey opted to increase cost reduction, from 42% last quarter to 46% this quarter; introduce new products/services or expanding into new markets, from 41% to 42%; and increase cash flow, up from 34% to 36%.

A number of areas of large increase were noted however, including inorganic growth, up from 19% of respondents to 25%; and reducing leverage levels, from 9% to 14%. Increase capital expenditure, raising dividends or share buyouts and disposing of assets, are considerably reduced in importance.

Remarking on the result of the latest survey, David Sproul, Chief Executive of Deloitte North West Europe, said, “Business sentiment is highly sensitive to political developments and surprises. The outcome of the General Election, like the result of last June’s EU referendum, was hugely unexpected and has knocked optimism. A period without such large shocks, and with the negotiations with the EU gaining direction and momentum, should help bolster business sentiment."

He added, “Nonetheless, this underscores the importance of the Brexit negotiations producing a favourable environment for UK businesses, with access to the skills and markets they need for their future success. Business and government must work closely together to achieve this.”