European corporates special — The more cash you have the more cash you hoard; and Investment is back: Harder, Better, Faster, Stronger?

The mind is much like tofu: It tastes like whatever you marinate it in. This week, we’re cultivating your intellectual palates with a hearty stock-taking of cash-concentration of NFCs in Europe and the implications for investment strategies. And we’re tickling your analytic taste buds with a spicy flavor of business investment that is gradually showing with the progressive easing of sanitary restrictions.

European Corporates: Cash-rich sectors get richer

The Covid-19 crisis has pushed up cash concentration among European non-financial corporates (NFCs): overall, NFCs now hold cash reserves equivalent to three months of turnover, more than half a month higher than pre-crisis averages, and it is the richest sectors and companies that have become even richer. After increasing considerably in 2020 in most European countries, NFCs’ cash has plateaued at high levels over the past few months. In France, total NFC deposits bring a cash-flow relief of more than four months of turnover, close to one month more than pre-crisis levels, while in the UK they are equivalent to close to 3.2 months, around 18 days above pre-crisis levels. Given the continued light lockdowns across major European countries over the past few months, cash positions have remained quite sticky, raising upside risks for defensive and offensive investments in 2021.

Further key take-aways:

• Looking at the financials available as of early April, the companies reporting the 10 largest increases in cash in 2020 posted a +56% increase (compared to +45% for the EU average) and were hoarding almost half of the total cash of listed firms.
• In addition, we find that large companies’ cash accounted for more than 70% of the total increase in NFC deposits in Germany at end-2020. However, it stood at 54% in France and close to or below 30% in Italy, Spain and the UK.
• Going forward, companies are likely to use around 50% of excess cash for financing rising working capital requirements and compensating for the strong rise in input prices against little pricing power. However, we also expect both defensive and offensive investment strategies in 2021.

Please find the full report here. 

Investment is back: Harder, better, faster, stronger?

In the short run, a demand catch-up and the reduction in spare capacities will drive a business investment recovery… With the progressive easing of sanitary restrictions, normalizing capacity utilization levels will push up business investment by +18.4% in the UK, +5.4% in France, +4.0% in the US and +2.5% in Germany. Country-level model elasticities show that business investment in Italy and the UK have the largest sensitivity to increasing aggregate demand and hence the highest potential for a fast catch-up in H2 2021. The key condition will be continued low interest rates: our model shows that loan-supply conditions are a significant determinant of investment growth in all countries, although the relation is weaker in Germany as companies enjoy higher profitability rates and thus self-financing capacity. Most of the rebound in business investment is expected to continue to be in software and IT equipment, where offensive investment strategies should pave the way for a new M&A cycle.

…But it could take up to four years to return to long-term growth trends. Our multi-country time series panel data model shows that in the medium-term, the business investment recovery will be mainly driven by aggregate demand and productivity, the evolution of fiscal pressure on corporates, public investment dynamics and bank financing availability. In our baseline scenario we find that the US will register the highest investment growth at horizon 2024 (on average over 7%), followed by the UK, France and Germany. But watch out for a potential corporate deleveraging cycle that could jeopardize our baseline forecasts. Credit conditions during the recovery phase may be tighter and excessive levels of corporate debt could limit companies’ ability to borrow once state-support schemes are phased out. In France, if companies embark on a deleveraging process as soon as H2 2022 to reach pre-Covid-19 bank-credit-to-value-added ratios by 2024, in the absence of further extensions to state-guaranteed loan reimbursements or debt forgiveness, the drag on business investment could reach EUR6bn (-2pp cumulative). In the US, faster deleveraging as of 2022 triggered by a corporate credit event and accentuated by mis-managed monetary policy tapering could also put a brake on investment growth. Returning to the pre-Covid-19 NFC credit-to-GDP ratio is expected to reduce business investment by USD170bn between 2023-2024 (-1.1pp).

As an alternative scenario, policymakers can catalyze the new investment cycle through strong crowd-in effects from public investment and supportive tax policies. First, by investing in new technologies, governments can ignite positive spillovers to the private sector that would lift potential growth and productivity. In France, a doubling of public investment spending (EUR20bn additional public investment) in 2021 would boost business investment by EUR0.5bn (+0.4pp of additional business investment growth). In Germany, the same amount of additional public investment would boost business investment by EUR0.8bn (+0.3pp) while in the UK the impact would be stronger (GBP0.6bn or +0.5pp). In the US, USD1trn in additional public investment could boost business investment by USD141bn (+1pp) in 2021, USD98bn (+0.7pp) in 2022 and USD65bn (+0.5pp) in 2023 compared to our baseline investment growth forecast. Second, easing fiscal pressures for corporates could also significantly support business investment in France, where the sensitivity of business investment to tax levels is higher, while in the US and the UK the new fiscal orientation could become a headwind.

In the long run, sustained economic growth and unleashed excess savings will be key. Our panel estimates show that the pace of economic growth and the financial asset accumulation of households are the key determinants for long-term investment. We find that a 1% increase in economic activity leads to a +1.25% increase in business investment in the long term. And 1% of additional households’ savings leads to the +0.4% of additional business investment. In France, an additional EUR100bn increase in households’ non-financial assets would increase business investment by +2.5% (EUR3.7bn), while in Germany it would boost business investment by +2% (EUR8bn).

Our complete analysis can be found here.