Is The Post-Crisis Corporate Re-Leveraging Rally Over?
Last week we pointed out the cognitive dissonance between the 'belief' that advanced economies are gradually (and rightly) deleveraging - as central banks maintain the status quo by kicking the can - and the reality of no actual deleveraging. Today, we look at the global corporate re-leveraging cycle that, as UBS notes, has struggled to gain traction after the initial recovery phase following the 2008/9 crisis. The corporate re-leveraging is broadly defined as trends in the use of cash as well as more active capital structure dynamics - a cycle that has ebbed and flowed over the last three years.
UBS Investment Research: Is that it for the re-leveraging cycle?
In 2011 we witnessed some encouraging trends: the corporate sector grew both dividends and capex by 15% and repurchased nearly 200% more stock versus 2010. In addition, net leverage increased on a global basis for the first time in several years – a positive given current low levels. This year, however, these trends are all set to weaken fairly significantly. Our latest edition of World Inc. shows forecasts for dividend growth slowing to just 5% and capex to 8%. Further, share buybacks are expected to shrink by over 30% and net leverage to drop.
The rolling crisis in Europe and continued uncertainty about the overall strength of the global economy has certainly played a role here insofar as these issues have impacted corporate confidence with regard to capital outlays and have also limited investment opportunities. Further, as our Asset Allocation team noted in a recent analysis, the opportunity cost of conservative cash management for the corporate sector has been minimal.
Given all of this then, it’s probably no surprise we’re seeing an apparent stalling out of the re-leveraging cycle. But while current opportunity costs may be low, a reluctance/inability for corporates to invest and/or return cash to shareholders is not without consequences.
Returns on capital are set to decline this year – the first time since before the financial crisis. RoE is being squeezed from all sides: asset turns, profit margins, and leverage. We continue to believe that leverage will be the most effective mechanism to support RoE in this environment. Increasing dividend payouts and repurchasing more stock would certainly help here.
With the corporate sector struggling to maintain aggregate earnings growth, it will be imperative – for both growth and returns – that the broader releveraging cycle not completely fade away (see illustrative charts below).