The Deloitte CFO Survey: A Cautious Start to 2016

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Q4 2015 The Deloitte CFO Survey The year ahead: A cautious start to 2016 Support among the Chief Financial Officers of the UK’s largest corporates for staying in the EU has narrowed, mirroring a drift towards greater scepticism on the part of the UK public in the second half of 2015. A clear majority of CFOs continue to favour remaining in the EU, but those expressing unqualified support for membership fell from 74% in the second quarter to 62% in the fourth quarter. Just 6% of CFOs favour leaving. But 4% did not express an opinion, and a sizeable minority, 28%, say their decision will depend on the results of the Prime Minister’s renegotiation of the UK’s membership of the EU. The outcome of these discussions is likely to emerge following the European Council meeting in February. With almost a third, or 32%, of CFOs undecided or undeclared, an eventual deal could significantly affect business attitudes to EU membership. January 2016 UK CFOs are downbeat about the outlook for growth in the euro area in 2016 despite a stronger than expected acceleration in activity seen in the region in 2015. Indeed, CFOs are more pessimistic about prospects for the euro area this year than for emerging market economies. CFO sentiment is most positive on the US and the UK economies. Nonetheless, doubts about the pace and sustainability of the global recovery are weighing on business sentiment. CFO confidence fell through 2015 and ended the year at its lowest level since the second quarter of 2012, when the euro area was in recession.

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The Deloitte CFO Survey Chart 1. CFO attitudes to EU membership % of CFOs who gave the following responses when asked whether it is in the interests of UK businesses for the UK to remain a member of the EU 80% 74% 70% 62% 60% 50% 40% 30% 23% 20% 10% 6% 2% 0% Yes 2015 Q2 No 2015 Q4 28% 1% Too early to say: Depends on results of renegotiation 4% Don't know, no strong opinion, prefer not to say

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The Deloitte CFO Survey Corporate risk appetite often reflects trends in financial markets. Thus the decline in the FTSE100 UK equity index since last summer has been accompanied by a softening in corporate risk appetite. The proportion of CFOs who think now is a good time to take risk dropped to 37% in the fourth quarter, down from 47% in the third quarter and a peak of 72% in late 2014. Such large moves in risk appetite feed through to the way in which companies run their finances. CFOs’ balance sheet strategies have become more defensive, with a sharper focus on cost control which now tops CFOs’ list of priorities. Meanwhile CFOs are placing less weight on growth through acquisitions and on capital spending. In recent months uncertainties, especially in emerging markets, have prompted the Bank of England to push back the timing of UK interest rate rises. The consensus in financial markets in mid-December was that the Bank will start raising interest rates in the second half of 2016. The pace of tightening is expected to be gentle, with three-month interest rates rising by a total of about 100bp, from a current 0.6% to 1.6% at the end of 2018. The corporate sector seems well positioned to cope with this sort of trajectory with 64% of CFOs reporting that a 100bp rate rise would have no effect, or a positive effect, on their plans for investment or employment. The surge in CFO confidence and risk appetite that started in late 2012 went into reverse in 2015. CFOs are upbeat about prospects for the US and UK economies, but see more risks elsewhere, especially in emerging markets and the euro area. CFOs have reacted by cutting back on risk-taking and sharpening their focus on cost control. This more defensive stance by the corporate sector points to slower growth in corporate hiring and capital expenditure in coming months.

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The Deloitte CFO Survey Authors Contacts Ian Stewart Chief Economist 020 7007 9386 [email protected] Ian Stewart Chief Economist 020 7007 9386 [email protected] Debapratim De Senior Economic Analyst 020 7303 0888 [email protected] Richard Muschamp CFO Programme Leader 020 7007 0724 [email protected] Alex Cole Economic Analyst 020 7007 2947 [email protected] For current and past copies of the survey, historical data and coverage of the survey in the media and elsewhere, please visit:

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Europe Public support for the UK’s membership of the EU fell in the second half of 2015. Between the end of May and the beginning of July four major opinion polls gave the ‘In’ camp an average lead of 18 percentage points. In the fourth quarter the same four polls showed the lead had been reduced to six percentage points. This decline in public support for the EU has coincided with a narrowing in support among CFOs. Chart 2. UK public opinion polls on EU membership Mid-year polling (May to July)     In ICM 31 May 47% Ipsos Mori 14-16 Jun 66% YouGov 19-24 Jun 44% Survation 29 Jun-6 Jul 45% Average   51% Out 33% 22% 38% 37% 33% End-year polling (October to December)   Ipsos Mori 17-19 Oct 52% 36% Survation 16-17 Nov 43% 40% YouGov 19-24 Nov 40% 38% ICM 6 Dec 43% 39% Average   45% 38% Don’t Know 20% 12% 18% 18% 17% Lead (In) +14 +44 +6 +8 +18   12% 18% 22% 17% 17% +16 +3 +2 +4 +6

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Europe CFOs are positive about prospects for growth in the US and the UK in 2016. But CFOs are strikingly downbeat about the euro area. Levels of pessimism about euro area growth in 2016 are greater than for emerging markets’ growth. Chart 3. Growth prospects Net % of CFOs who are optimistic about prospects for growth in the following regions in 2016 100% 82% 80% 68% 60% 40% 20% 0% -6% -20% -25% Emerging markets excluding China* -40% -27% Euro area -5% Japan China -18% Emerging markets including China* UK *GDP-weighted estimate based on CFO readings for emerging markets excluding China, and for China US

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Europe Although CFOs are negative about prospects for the euro area, activity in the region picked up through 2015, and at a rather faster rate than expected. German business confidence ended 2015 at higher levels than at the beginning of the year. Meanwhile US manufacturing activity dropped to a six-and-a-half year low in November. Chart 4. German and US business confidence German Ifo Business Climate Index and US ISM Purchasing Managers Index (Manufacturing) 65 120 115 60 US ISM (RHS) 110 55 105 50 100 45 95 German IFO (LHS) 40 90 35 85 80 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Dec 15 30

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Risk appetite wanes Other than a brief, post-election bounce, corporate risk appetite has been trending down for over a year. Just 37% of CFOs say that now is a good time to take greater risk onto their balance sheets, down from a peak of 72% in Q3 2014. Chart 5. Risk appetite % of CFOs who think this is a good time to take greater risk onto their balance sheets 80% 70% 60% 50% 40% 30% 20% 10% 0% 2007 Q3 08 Q1 08 Q3 09 Q1 09 Q3 10 Q1 10 Q3 11 Q1 11 Q3 12 Q1 12 Q3 13 Q1 13 Q3 14 Q1 14 Q3 15 Q1 15 Q3

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Risk appetite wanes The fall in corporate risk appetite has been mirrored by a decline in investor risk appetite. The second half of 2015 saw a rise in risk aversion among investors, as they moved from riskier assets including equities into safer government bonds. Chart 6. CFO and investor risk appetites % of CFOs who think this is a good time to take greater risk onto their balance sheets (LHS) and change in UK equities over bonds (RHS) % CFOs saying now is a good time to take risk (RHS) 75 70 80 70 65 60 60 Equities vs bonds (LHS) 50 55 50 40 45 30 40 20 35 10 30 Jan 07 Sep 07 May 08 Jan 09 Sep 09 Mar 10 Jan 11 Sep 11 May 12 Jan 13 Sep 13 Mar 14 Jan 15 Sep 15 0

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Risk appetite wanes Sentiment among large corporates has declined for the third consecutive quarter. CFO optimism is at its lowest level since the second quarter of 2012, when the euro area was in recession and gripped by concerns that the single currency might break up. Chart 7. Business confidence Net % of CFOs who are more optimistic about financial prospects for their company now than three months ago More optimistic 60% 40% 20% 0% Less optimistic -20% -40% -60% -80% 2007 Q3 07 Q4 08 Q1 08 Q4 09 Q1 09 Q4 10 Q1 10 Q4 11 Q1 11 Q4 12 Q1 12 Q4 13 Q1 13 Q4 14 Q1 14 Q4 15 Q1 15 Q4

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Focus on cost control For the first time in a year CFOs rate cost reduction as their number one priority for the next 12 months. CFOs are also placing greater emphasis on other defensive strategies such as increasing cash flow, disposing of assets and reducing leverage. In contrast, CFOs are placing rather less emphasis on growth strategies such as introducing new products and services, expanding by acquisition and increasing capital expenditure. Chart 8. Corporate priorities in the next 12 months % of CFOs who rated each of the following as a strong priority for their business in the next 12 months Reducing costs 34% Introducing new products/ services or expanding into new markets 38% 39% 37% 34% Increasing cash flow 19% 22% Expanding by acquisition 17% 19% Increasing capital expenditure Raising dividends or share buybacks 44% 8% 14% Disposing of assets 13% 9% Reducing leverage 12% 10% 0% 10% 2015 Q4 20% 30% 2015 Q3 40% 50%

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Focus on cost control The increased focus on defensive strategies means that CFOs are more defensive than at any time in the last three years. Chart 9. CFO priorities: Expansionary vs. defensive strategies 39% 37% 35% 33% 31% Defensive strategies 29% 27% 25% 23% Expansionary strategies 21% 19% 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 Q4 Q1 Q4 Q1 Q4 Q1 Q4 Q1 Q4 Q3 Q1 Arithmetic average of the % of CFOs who rated expansionary and defensive strategies as a strong priority for their business in the next 12 months. Expansionary strategies are introducing new products/services or expanding into new markets, expanding by acquisition and increasing capital expenditure. Defensive strategies are reducing costs, reducing leverage and increasing cash flow.

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Inflation and interest rates CFOs’ expectations for inflation fell between the third and fourth quarters of 2015. Chart 10. CFO inflation expectations % of CFOs who expect consumer price inflation in the UK to lie between the following ranges in two-years’ time 60% 51% A narrow majority (51%) now expect 50% inflation to remain below 1.5% in 40% two-years’ time. 39% 56% 44% 30% The fall in CFOs’ expectations for inflation coincided with downgrades to both market and Bank of England forecasts for inflation in 2016. 20% 10% 0% 5% 1% Below zero 2015 Q3 0-1.5% 2015 Q4 1.6%-2.5% 4% Above 2.5%

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Inflation and interest rates As inflation forecasts have fallen so, too, have financial market expectations for future interest rates. Expectations for UK interest rates at the end of 2016, 2017 and 2018 are now lower than they were in the summer of 2015. Chart 11. Financial market expectations for UK interest rates UK market rate expectations for end-year three-month interest rates 2.5 2.0 at Dec ’18 1.6% 1.5 at Dec ’17 1.3% at Dec ’16 0.9% 1.0 Now 0.6% 0.5 0.0 Jun 15 Jul 15 Aug 15 Sep 15 Oct 15 Nov 15 Dec 15

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Inflation and interest rates The corporate sector seems fairly well positioned to cope with the cumulative 100bp rate rise priced in by financial markets in the next three years. Almost two-thirds of CFOs say that interest rates would have to rise by more than 100 basis points before their businesses cut planned investment or employment. Chart 12. Effect of rate rises on corporate spending % of CFOs reporting that the Bank of England’s base rate could rise by the following amounts before their business responds by cutting planned investment or employment 30% 25% 36% say rate rises of ≤100bp would affect investment/jobs 26% 24% 21% 20% 15% 10% 5% 0% 10% 8% 64% say rates would have to rise by >100bp to affect investment/ jobs 10% 2% 25 basis points 50 basis points 100 basis points 200 basis points 300 basis points More than 300 basis points A rise in interest rates would be good for my business

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Weaker margins Expectations for revenue and margin growth dipped in the second half of 2015. While a majority of CFOs still expect UK corporate revenues to increase over the next 12 months, the outlook for revenues and margins is at its weakest for two-and-a-half years. Chart 13. Outlook for corporate revenues and margins Net % of CFOs who expect UK corporates’ revenues and margins to increase over the next 12 months Increase 90% Revenues 70% 50% Operating margins 30% Decrease 10% -10% -30% -50% -70% 2010 10 11 11 11 11 12 12 12 12 13 13 13 13 14 14 14 14 15 15 15 15 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

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Weaker margins Our panel of large corporates continues to enjoy good access to credit. The cost of credit is not far off its lowest reported levels, while credit availability is near to all-time highs. 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% 2007 Q3 Cost of credit (LHS) Availability of credit (RHS) 07 Q4 08 Q1 08 Q4 09 Q1 09 Q4 10 Q1 10 Q4 11 Q1 11 Q4 12 Q1 12 Q4 13 Q1 13 Q4 14 Q1 14 Q4 15 Q1 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% 15 Q4 Credit is cheap Credit is costly Credit is cheap Credit is costly Chart 14. Cost and availability of credit Net % of CFOs reporting credit is costly and credit is easily available

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Weaker margins Bank borrowing remains the most attractive source of funding for CFOs, with a significant majority (86%) viewing it as an attractive source of external funding. As has been the case for the last five years, CFOs view equity issuance as a less attractive source of funding than bond issuance or bank borrowing. Chart 15. Favoured source of corporate funding Net % of CFOs reporting the following sources of funding as attractive Bank borrowing 100% Unattractive Attractive 80% Bond issuance 60% 40% 20% Equity issuance 0% -20% -40% -60% 2007 Q3 07 Q4 08 Q1 08 Q4 09 Q1 09 Q4 10 Q1 10 Q4 11 Q1 11 Q4 12 Q1 12 Q4 13 Q1 13 Q4 14 Q1 14 Q4 15 Q1 15 Q4

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CFO Survey: Economic and financial context The macroeconomic backdrop to the Deloitte CFO Survey Q4 2015 The International Monetary Fund cut its forecast for global growth in 2015 and 2016. Activity in emerging markets continued to disappoint, with economists nudging down their forecasts for growth in most emerging economies. Growth in the advanced economies continued and broadened, though indicators of industrial activity have generally softened, partly as a result of weaker export market demand. After a short-lived market rally in October, equities, especially those in emerging markets, lost value towards the end of the year. In early December the oil price fell below $40, to the lowest level in seven years; metals prices also softened. Inflation remained close to zero in the US, the euro area and the UK and inflation forecasts for 2016 continued to decline. The European Central Bank’s announcement of a further round of Quantitative Easing fell short of market expectations, though the ECB’s President subsequently reassured markets that there were “no limits” to the tools the ECB could use to fight deflation. As widely anticipated the US Federal Reserve raised interest rates on 16th December, the first time US interest rates have been increased in almost ten years.

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CFO Survey: Economic and financial context UK GDP growth: Actual and forecast (%) 5% Forecasts 3% 1% Quarter-onquarter growth -1% -3% Year-on-year growth -5% -7% 2007 2008 2009 2010 2011 2012 2013 Source: ONS, consensus forecasts from The Economist and Deloitte calculations 2014 2015 2016

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CFO Survey: Economic and financial context FTSE 100 price index 7000 6500 6000 5500 5000 4500 4000 3500 3000 2008 2009 2010 Source: Thomson Reuters Datastream 2011 2012 2013 2014 2015

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CFO Survey: Economic and financial context UK private and public sector job growth (thousands) 600 500 400 300 200 100 0 -100 -200 -300 -400 Q1 2007 Public Q4 2007 Q4 2008 Private Source: Thomson Reuters Datastream Q4 2009 Q4 2010 Q4 2011 Q4 2012 Q4 2013 Q3 2014 Q2 2015

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CFO Survey: Economic and financial context UK annual CPI inflation (%) 9 8 7 6 5 4 3 2 1 Source: Thomson Reuters Datastream 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 -1 1990 0

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Two-chart summary of key survey messages CFO attitudes to EU membership % of CFOs who gave the following responses when asked whether it is in the interests of UK businesses for the UK to remain a member of the EU 80% 70% 60% 74% 62% 50% 40% 30% 23% 20% 10% 2% 0% Yes 2015 Q2 6% No 2015 Q4 28% 1% 4% Too early Don’t know, no strong to say: opinion, Depends on prefer not results of to say renegotiation CFO priorities: Expansionary vs. defensive strategies 39% 37% 35% 33% 31% 29% 27% 25% 23% 21% 19% Defensive strategies Expansionary strategies 10 11 11 12 12 13 13 14 14 15 15 Q3 Q1 Q4 Q1 Q4 Q1 Q4 Q1 Q4 Q1 Q4

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About the survey This is the 34th quarterly survey of Chief Financial Officers and Group Finance Directors of major companies in the UK. The 2015 fourth quarter survey took place between 11th November and 2nd December. 137 CFOs participated, including the CFOs of 24 FTSE 100 and 62 FTSE 250 companies. The rest were CFOs of other UK-listed companies, large private companies and UK subsidiaries of major companies listed overseas. The combined market value of the 99 UK-listed companies surveyed is £374 billion, or approximately 18% of the UK quoted equity market. The Deloitte CFO Survey is the only survey of major corporate users of capital that gauges attitudes to valuations, risk and financing. To join our panel of CFO respondents and for additional copies of this report, please contact Anthea Neagle on 020 7303 0116 or email [email protected] Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of DTTL and its member firms. Deloitte LLP is the United Kingdom member firm of DTTL. This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication. © 2016 Deloitte LLP. All rights reserved. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198. Designed and produced by The Creative Studio at Deloitte, London. J3512

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