The Deloitte CFO Survey

Q2 2016

1

Brexit hits confidence Sentiment among Chief Financial Officers of the UK’s largest corporates has fallen sharply in the wake of the EU referendum. The second quarter survey took place between 28th June and 11th July, and provides a detailed picture of thinking among large UK-based businesses in the light of the vote.

Perceptions of uncertainty have soared in the wake of the vote to levels associated with the euro crisis five years ago. The spike in uncertainty has had a toxic effect on business sentiment with optimism dropping to the lowest level since the survey started in 2007. Corporate willingness to take risk has seen its largest ever decline.

This quarter we asked CFOs what effect they expected an exit from the EU to have on their own spending plans over the next three years. 58% expected capital spending to be somewhat or significantly lower and 66% expected hiring to be lower over this period.

CFOs do not seem to be waiting for growth to slow before adjusting direction.

There has been a marked shift to more defensive balance sheet strategies in the wake of the referendum. For the first time in more than a year the top two balance sheet priorities for major UK corporates are defensive – reducing costs and increasing cash flow.

Expectations for growth in capital spending, hiring and discretionary spending are at levels that were last seen just before the so-called “double dip” slowdown of 2012.

More than two-thirds of our CFO panel believe that leaving the EU will lead to a deterioration in the UK business environment in the long term. About 20% expect little change and 12% expect an improvement.

When asked what the authorities can do to support economic activity in the wake of Brexit an overwhelming majority – 91% of CFOs – said that giving a strong signal about the government’s aims in the negotiations with the EU should be a strong priority.

Progress on this front could yet see corporate sentiment head higher.

AuthorsIan StewartChief Economist020 7007 9386istewart@deloitte.co.uk

Debapratim DeSenior Economic Analyst020 7303 0888dde@deloitte.co.uk

Alex ColeEconomic Analyst020 7007 2947alecole@deloitte.co.uk

Key contactsIan StewartChief Economist020 7007 9386istewart@deloitte.co.uk

Richard MuschampCFO Programme Leader020 7007 0724rmuschamp@deloitte.co.uk

For current and past copies of the survey, historical data and coverage of the survey in the media and elsewhere, please visit:

www.deloitte.co.uk/cfosurvey

Chart 1. Business optimismNet % of CFOs who are more optimistic about the financial prospects of their company than three months ago

-90%

-70%

-50%

-30%

-10%

10%

30%

50%

70%

2015Q4

2015Q1

2014Q2

2013Q3

2012Q4

2012Q1

2011Q2

2010Q3

2009Q4

2009Q1

2008Q2

2007Q3

Policy uncertainty hits risk appetite

15 days after EU referendum

15 days after Lehman collapse

Now vs post- Lehman trough

FTSE100 (change) +4.8% -13.4% +47%FTSE250 (change) +3.2% -16.5% +67%Consumer confidence (level) -9 -36 +27 pointsCFO risk appetite (level) -84 -98 +14 pointsGDP growth %YoY (forecast for next full year*)

0.4% -4.3% +4.7%

₤/$ exchange rate (change) -11.1% -3.4% -3.8%CFO optimism (level) -70 -60 -10 pointsEuropean Economic Policy Uncertainty Index (level)

394 217 +177*

*2009 vs 2017*peak reached post-euro crisis

Sources: Thomson Reuters Datastream, Deloitte CFO Survey, GfK Consumer Confidence Index, www.PolicyUncertainty.com and Consensus Economics

Chart 3. Brexit compared to Lehman Brothers’ bankruptcyImmediate post-Brexit market and economic indicators compared to that following Lehman Brothers’ bankruptcy

The UK’s vote to leave the EU came as a surprise to financial markets.

However, the shock seen in the immediate aftermath of the result has not been as large as that which followed the collapse of Lehman Brothers in September 2008. While sterling has fallen faster, UK equities have proved more resilient. Consumer confidence recorded its sharpest monthly fall in almost 22 years in July but remains much stronger than in the aftermath of Lehman Brothers’ collapse.

Corporate risk appetite has now fallen for the fourth consecutive quarter.

Following the EU referendum, just 8% of CFOs say that now is a good time to take greater risk onto their balance sheets, the lowest level in more than six years.

Markets have not interpreted Brexit as a financial crisis, but the vote has had a profound effect on perceptions of uncertainty.

CFO perceptions of uncertainty are now at levels last seen during the euro crisis in 2012, while indicators of European economic policy uncertainty are at their highest levels on record.

Better than previous

Worse than previous

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The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

0%

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80%

Chart 2. Corporate risk appetite% of CFOs who think this is a good time to take greater risk onto their balance sheets

2016Q2

2015Q3

2014Q3

2013Q3

2012Q3

2011Q3

2010Q3

2009Q3

2008Q3

2007Q3

050

100150200250300350400450

Chart 4. Uncertainty% CFOs who rate the level of external financial and economic uncertainty facing their business as above normal, high or very high and European Economic Policy Uncertainty Index*

2016201520142013201220112010200920082007200620052004200320022001

* The Economic Policy Uncertainty Index measures policy-related economic uncertainty based on newspaper coverage of policy uncertainty, and covers France, Germany, Italy, the Netherlands, Spain and the UK.Source: “Measuring Economic Policy Uncertainty” by Scott R. Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com

0%

20%

40%

60%

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100%

120%

European Economic Policy Uncertainty (LHS) CFO uncertainty (RHS)

Weaker growth outlook

Growth expectations for the UK economy, for both 2016 and 2017, have fallen throughout the year.

Following the Brexit vote, economists now expect growth of 0.4% in 2017, down from 2.1% forecast on the eve of the referendum in June.

Expectations for revenue and margin growth have been cooling since late 2015 and fell sharply in the second quarter.

CFO expectations for both revenue and margin growth are now at their lowest levels since this question was first asked in 2010.

On balance, our panel of large corporates continues to view credit as being available and cheap.

However, credit conditions are perceived as being tighter than they have been in recent years – with credit availability now at its lowest since Q4 2012.

0.0%

0.5%

1.0%

1.5%

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2.5%

Jul-16Jun-16May-16Apr-16Mar-16Feb-16Jan-16

Chart 5. Evolution of 2016 and 2017 GDP growth forecastsEvolution of consensus GDP growth forecasts for the UK economy in 2016 and 2017 (% YoY)

2016 2017

-70%

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-10%

10%

30%

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70%

90%

Chart 6. Outlook for corporate revenues and marginsNet % of CFOs who expect UK corporates’ revenues and margins to increase over the next 12 months

2016 Q2

2016 Q1

2015 Q4

2015 Q3

2015 Q1

2014 Q3

2014 Q1

2013 Q3

2013 Q1

2012 Q3

2012 Q1

2011 Q3

2011 Q1

2010 Q3

Margins Revenues

-100%-80%-60%-40%-20%

0%20%40%60%80%

100%

-100%-80%-60%-40%-20%0%20%40%60%80%100%

Chart 7. Cost and availability of credit Net % of CFOs reporting credit is costly and credit is easily available

2016

Q2

2015

Q3

2015

Q1

2014

Q1

2014

Q3

2013

Q1

2013

Q3

2012

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Cost of credit (LHS) Availability of credit (RHS)

Cred

it is

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apCr

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is c

ostly

Credit is hard to getCredit is available

3

The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

Sharper focus on defensive strategies

Defensive strategies – reducing costs and increasing cash flow – are the top two balance sheet priorities for major UK corporates. 47% of CFOs rate cost reduction as a strong priority, the highest reading in three and a half years.

Conversely, expansionary strategies, such as introducing new products or services or raising capital expenditure, have dropped sharply down the list of priorities.

CFO strategies have turned markedly more defensive. The mix of balance sheet strategies is at its most defensive in four years and least expansionary in six.

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

0% 10% 20% 30% 40% 50% 60%

Raising dividends or share buybacks

Increasing capital expenditure

Disposing of assets

Expanding by acquisition

Reducing leverage

Introducing new products/services orexpanding into new markets

Increasing cash flow

Reducing costs

2016 Q12016 Q2

47%40%

41%37%

27%43%

21%

16%

13%

18%

11%12%

16%7%

3%12%

15%

20%

25%

30%

35%

40%

Chart 9. CFO priorities: Expansionary vs defensive strategies

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.

2016 Q2

2016 Q1

2015 Q4

2015 Q3

2015 Q1

2014 Q3

2014 Q1

2013 Q3

2013 Q1

2012 Q3

2012 Q1

2011 Q3

2011 Q1

2010 Q3

Expansionary strategies Defensive strategies

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The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

-100%-80%-60%-40%-20%

0%20%40%60%80%

100%

Chart 10. Outlook for capital expenditure, hiring and discretionary spendingNet % of CFOs who expect UK corporates’ capital expenditure, hiring and discretionary spending to increase over the next 12 months

2016 Q2

2016 Q1

2015 Q4

2015 Q1

2014 Q4

2014 Q1

2013 Q4

2013 Q1

2012 Q4

2012 Q1

2011 Q4

2011 Q1

2010 Q4

Discretionary spending Hiring Capital expenditure

Dec

reas

eIn

crea

se

Chart 11. Effect of Brexit on investment plans decisions% of CFOs who expect M&A activity, capital expenditure, hiring and discretionary spending by their business to decrease over the next three years as a consequence of Brexit

0%

10%

20%

30%

40%

50%

60%

70%

80%

Discretionary spendingHiringCapital expenditureMergers & acquisitions

40%

58%66%

74%

Factors affecting investment

In keeping with the move towards defensive strategies, CFO expectations for growth in capital spending, hiring and discretionary spending by UK corporates have fallen sharply in the second quarter. They are now at levels last seen just before the so-called “double dip” slowdown of 2012.

This quarter we asked CFOs what effect they expected an exit from the EU to have on their own spending plans over the next three years. 58% expect capital spending to be lower and 66% expect hiring to be lower over this period.

In addition, more than two-thirds of our CFO panel believe that leaving the EU will lead to a deterioration in the UK business environment in the long term. About 20% expect little change and 12% expect an improvement.

5

The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

Policy response to Brexit

On what the authorities could do to support economic activity, an overwhelming majority – 91% of CFOs – say that setting a clear direction for the government’s aims in the negotiations with the EU should be a strong priority.

Maintaining the solvency and liquidity of the banking system was ranked second, with 88% rating it as a strong priority. In third place came pursuing the government’s budget deficit reduction plan, with 25% saying it should be a strong priority.

The substantial post-referendum depreciation in sterling probably lies behind a sharp rise in CFOs’ expectations for inflation.

30% of CFOs expect inflation to be above 2.5% in two years’ time, up from just 2% in the first quarter.

Enthusiasm for cutting interest rates, restarting quantitative easing or cutting taxes was muted – in each case fewer than 10% of CFOs rated these strategies as strong priorities.

CFOs have reduced their expectations for interest rates. A majority – 54% – now expect the Bank of England’s base rate to be below its current all-time low of 0.5% in a year’s time.

6

The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

Chart 12. Policy response to Brexit% of CFOs who think the following strategies should be a strong priority forpolicymakers as they respond to the outcome of the EU membership referendum

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Cut interest rates

Undertake additional quantitative easing

Cut taxes

Raise public expenditure

Continue to pursue the governmentʼsdeficit reduction plans

Maintain the solvency and liquidity of thebanking system

Give a clear direction for theUKʼs negotiations with the EU

3%

6%

9%

16%

25%

88%

91%

Chart 13. Interest rate expectations% of CFOs who expect the Bank of England’s base rate to be at the following levels in a year’s time

0%

10%

20%

30%

40%

50%

60%

1.25%1%0.75%0.50%Below 0.5%

2016 Q1 2016 Q2

54% 57%

0%

38%

29%

2% 2% 2%3%

12%

Chart 14. Inflation expectations% of CFOs who expect consumer price inflation in the UK to lie between the following ranges in two years’ time

0%

10%

20%

30%

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50%

60%

70%

Above 2.5%1.6%-2.5%0-1.5%Below Zero

2016 Q1 2016 Q2

2%1%

58%

30%

2%

30%

40% 38%

CFO Survey: Economic and financial context

The macroeconomic backdrop to the Deloitte CFO Survey Q2 2016The outlook for global growth softened in the second quarter with the International Monetary Fund making its fourth consecutive reduction to global growth forecasts. China’s slowdown and weak commodity prices are taking a deeper toll on emerging markets than expected and advanced economies are still struggling to escape the legacies of the financial crisis. The UK’s vote to leave the EU triggered sharp reductions in average UK growth forecasts and euro area growth forecasts edged lower. Early indicators suggest the vote has had a dampening effect on UK activity; construction activity fell at its fastest pace in seven years in June and consumer confidence saw its sharpest fall in almost 22 years, following the referendum. The Bank of England surprised markets by keeping UK rates on hold in July but hinted that it will ease policy in August. S&P and Fitch downgraded the UK’s credit rating. Concerns about the health of the Italian banking system re-surfaced. Yields on government bonds declined across the world with markets assuming that slower global growth and the Brexit vote would keep interest rates lower for longer. Sterling fell almost 15% against the dollar in the weeks after the vote. After sharp immediate losses, the UK FTSE 100 and FTSE 250 rallied strongly as part of a global rise in risk appetite driven by expectations of easier monetary policy and better US economic data.

Private sector

Chart 17. UK private and public sector job growth (thousands)

Source: Thomson Reuters Datastream

Public sector

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Chart 18. UK annual CPI inflation (%)

Source: Thomson Reuters Datastream

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The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

Quarter-on-quartergrowth

Year-on-yeargrowth

Source: ONS, consensus forecasts from The Economist and Deloitte calculations

20172016201520142013201220112010200920082007-7

-6-5

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Chart 15. UK GDP growth: Actual and forecast (%) Chart 16. FTSE 100 price index

Source: Thomson Reuters Datastream

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About the survey

This is the 36th quarterly survey of Chief Financial Officers and Group Finance Directors of major companies in the UK. The 2016 second quarter survey took place between 28th June and 11th July. 132 CFOs participated, including the CFOs of 25 FTSE 100 and 57 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 94 UK-listed companies surveyed is £365 billion, or approximately 16% 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 aneagle@deloitte.co.uk.

Two-chart summary of key survey messages

The Deloitte CFO Survey Q2 2016 | Brexit hits confidence

Uncertainty% of CFOs who rate the level of external financial and economic uncertainty facing their business as above normal, high or very high

45%

55%

65%

75%

85%

95%

2016Q1

2015Q3

2015Q1

2014Q3

2014Q1

2013Q3

2013Q1

2012Q3

2012Q1

2011Q3

2011Q1

2010Q3

-100%-80%-60%-40%-20%

0%20%40%60%80%

100%

Outlook for capital expenditure, hiring and discretionary spendingNet % of CFOs who expect UK corporates’ capital expenditure, hiring and discretionary spending to increase over the next 12 months

2016 Q2

2015 Q4

2015 Q1

2014 Q4

2013 Q1

2012 Q4

2011 Q1

2010 Q4

Discretionary spending HiringCapital expenditure

Dec

reas

eIn

crea

se