Fitch Ratings said that the fall in European corporates’ aggregate cash holdings since 2010 and rising net debt reflects increased shareholder returns, merger and acquisition (M&A) and capital expenditure (capex). But this spending is dominated by a number of large names in stable sectors. For most corporates, discretionary spending remains manageable or can be scaled back at the sign of a steep macroeconomic deterioration.
The credit ratings agency (CRA) based its findings on a sample of 180 large Fitch-rated European corporates, which showed that aggregate balance-sheet cash fell around 2% (€11bn) in 2011, but holdings are still one-third above their level in 2007. Cash only tells part of the story: aggregate net debt increased by a more material 8% (€77bn), suggesting significant cash outflows. According to Fitch, this is inconsistent with reports that many companies still appear cautious about deploying cash. It suggests companies are either being more constructive in their use of cash than widely assumed or that their ability to generate cash from operations is weakening.
Fitch doesn’t believe operating cash generation is the problem, as the sample’s aggregate funds from operations (FFO), a measure of operating cash flow after interest and tax, increased by 8% between 2010 and 2011. This increase was almost entirely offset by working capital outflows; operating cash generation in 2011 was on a par with 2010.
Fitch forecasts FFO to be little changed in 2012, albeit with some weaker sectors, under its base case scenario, which predicts low growth and a muddle-through outcome for the eurozone. CRA has written about other eurozone scenarios that could lead to a worse outcome.
Capex and dividends, which Fitch classifies as partially discretionary, rose in 2011, with aggregate expenditure increasing by 11% and 16% respectively (about €60bn in total). Increases were widespread across different sectors. However, even these increases left the sample with a healthy (€26bn) positive FCF.
Higher share buybacks and M&A spending turned this cash flow negative, said Fitch. While M&A is still only about one-third of its pre-recession peak in 2008, buybacks have risen to 70% of that level. Such an increase would typically represent a significant credit concern. But this increase was limited to a small number of players in the stronger sectors, including oil and gas, natural resources, consumer and pharmaceuticals, which have generally been able to accommodate such moves at current rating levels.
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