Many companies are feeling good amid strong earnings, solid markets and a tax windfall, which is precisely the moment to start planning ahead.
A year ago, the biggest question many companies and investors faced was how to act in the face of so much uncertainty. Today, amid a string of strong quarterly earnings, synchronous global growth, and still relatively low inflation and interest rates—much of which is reflected in stock market performance—the same market participants are wondering how they can best position to benefit while the going is good—and how to prepare for when the market turns.
The end of easy money is something a lot of companies say they understand but may not be adequately prepared for.
“A strong economy, tax reform and deregulation have been broad tailwinds for many of our businesses,” said Melissa James, Morgan Stanley’s Vice Chairman of Global Capital Markets, when she recently opened the firm’s second Financial Decision Makers conference in New York. “Now, as we conduct our own strategic planning, we’re focused on the future, and making sure we’re nimble enough to pivot, because we know that those tailwinds can turn into headwinds unexpectedly.”
Indeed, swings in market volatility that took many by surprise earlier this year have now become the new normal. “One of the things we can probably all agree on is that increased volatility is going to be with us for a while,” James said to the gathered audience of chief financial officers and treasurers from major corporations, many of whom nodded in agreement. “So we need to be prepared for any possibility.”
The Post-Easy Era
Times are good. Double-digit revenue growth with strong operating margins combined with recent U.S. tax cuts have resulted in many companies flush with cash. The question of what to do with that windfall was top of mind for the corporate officers who hold the purse strings.
“A lot of companies will return that cash to shareholders mainly through stock buybacks,” said Tomer Regev, Managing Director and Co-Head of Corporate Finance and Transaction Strategies. “But that’s going to be a short-term boost for the most part. The question is what are you going to do long-term?”
And then there are those headwinds. While the global economy is growing in sync right now, with emerging markets just entering the early stages of an upturn, many developed markets, like the U.S., are in the late stages of their growth cycle, fueled for years by low inflation and near-zero interest rates. Now, interest rates are steadily rising and central banks like the Federal Reserve are expected to continue tightening the credit spigot, which means corporates face higher costs for capital. “The end of easy money is something a lot of companies say they understand but may not be adequately prepared for,” Regev counseled.
Investing in Future Strength
Conditions for a perfect storm may take years to develop, or be defused along the way, Regev said. Still, the question that should be top of mind is what separates the companies that can weather a downturn and emerge stronger, from those that can’t and don’t? Regev’s analysis shows that during the 2008 recession, companies with stronger margins relative to peers with manageable leverage outperformed by a wide margin. When the market ultimately recovered, those companies that reinvested capital in their business, while expanding their margins most, significantly outperformed their peers. Even companies that didn't increase margins but deployed capital performed similarly to companies with just significant margin expansion, demonstrating the value the market ascribes to capital investment.
“The real difference, however, comes down to strategic planning and execution,” said James.
Options abound. Mergers and acquisitions, for example, have been very active in 2018 and are anticipated to continue, with more and bigger deals still to come, according to Susie Huang, Head of M&A for the Americas at Morgan Stanley. After languishing for years, capital expenditure, where companies invest in new equipment, hardware and software upgrades, and other assets to boost production, is also expected to pick up significantly.
“There are still great deals out there to do and growth opportunities to capture, and with the amount of lead time and preparation required for proper execution, the time is now,” James added.