European corporates will not go on a spending spree in 2012 despite many being able to access capital markets at historically low rates, according to Fitch Ratings. But if the markets’ current confident tone persists into 2013, and global economic growth starts to accelerate, increases in discretionary spending on mergers and acquisitions (M&As) and share buybacks could again represent a threat to corporate credit quality.
The credit ratings agency (CRA) says that capital expenditure (capex) and dividends, the other key items of discretionary corporate spending, are already at healthy levels for large corporates, if not for many of their parent economies. Capex and dividends rose above their pre-recession peaks in 2011 and as a result net debt increased by 8% in that year, while precautionary cash holdings fell 1%. But the resurgence of global economic uncertainties earlier this year has provided neither the justification nor the incentive for further increases in discretionary spending. Fitch expects net debt at the end of 2012 to be broadly the same as in 2011.
In the last two years many companies have returned to share buybacks, but in a disciplined manner so as not to weaken their credit quality. Many conservatively-financed companies in robust sectors have returned truly excess cash, and numerically this brought the level of buybacks to 70% of its pre-recession highs in 2011. What have not happened are the sort of buybacks that have been very damaging to corporates’ credit quality in the past, with companies in weaker sectors taking on additional leverage to return cash to shareholders, often to mask operational issues.
Of all the companies in the CRA’s sample of 180 of the largest western European corporates, three quarters of buyback volume is anticipated to come from A category or higher rated issuers. Fitch expects only one speculative-grade name in its sample, Telenet, to buy back shares in 2012.
Telenet was downgraded last month to B+ from BB on the announcement of this €656m debt-funded programme. Telenet is a special case however; the buyback allowed its major shareholder, Liberty Global, to obtain a majority stake in the company. The move is also not as risky as it might look; as a well-established cable operator Telenet has a history of strong cash generation and has delevered from such positions before.
M&A spending remains very depressed, at about 40% of its pre-recession level. Despite improved market sentiment, the CRA does not expect a broad increase in the short term. The economic environment in developed and emerging markets is still uncertain, and prices in more promising markets remain high. This makes it hard to make a compelling business case for major M&A to still-conservative boards.
If the current market confidence persists toward the end of 2012, and the growth picture improves, by 2013 companies may begin to feel and act differently. Fitch adds that if the sector did want to go on a spending spree, it has the resources to do so.
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