Buchler Phillips Quarterly Bulletin No.10

Eddie’s mission to build lasting value

The worlds of sport and business are both regularly guilty of short-termism. Under pressure to perform, banks, institutional investors and management are forced to report progress formally as often as quarterly. Internally, it’s monthly or even weekly. How many consecutive matches will a Premiership football manager get away with losing before he’s replaced? These days, not too many.

England Rugby’s Eddie Jones is playing the long game. After back-to-back Six Nations successes, not only is he going for a hat-trick this year, but he says he’s squarely focused on winning the World Cup in 2019. Accepting an extended contract in recent weeks, Jones stressed that he’s building “sustainable success”, painstakingly optimising his mix of experienced players and young talent “to leave a great team for the next guy to keep winning with.”

Too much short termism often produces poor decision-making in business, sometimes prompting management behaviour that moves quickly from self-serving to unethical and even illegal. Companies at present face an inordinate number of economic and political factors beyond their control.  Weathering these storms requires business leaders to be more measured, consistent and focused than ever.

For whom the bell tolls

WHEN Tarmac’s construction arm was spun out in 1999 and rebranded as Carillion, the new name was said to be a corruption of ‘carillon’, a peal of bells sounding a clear, new identity to the industry. By January this year, the peal had slowed to a death knell, as Britain’s second largest contractor collapsed spectacularly and controversially.

As the recriminations continue, a light has been shone on the industry’s precarious business model of gigantic projects yielding meagre profits. Carillion’s debts and pension deficit were for a long time wholly inconsistent with this model. A 3% margin on sales of £4bn left little wriggle room – that’s why former CEO Richard Howson’s apparent strategy of chasing risky low-margin contracts, while keeping some subcontractors unpaid for 120 days, was unsustainable.

The whiff of desperation about cash management did not elude the hedge funds which made fortunes shorting Carillion shares as far back as 2013. The inexplicably low tenders for contracts, now obviously to keep cash circulating, seem to have prompted fewer questions.

The revenue profile is, ultimately, why the company has gone into liquidation, rather than administration.  It is clear that there are no viable parts of the business to sell. The contracts are certainly not meaningful assets to borrow against.

What remains baffling for the corporate recovery community is why the seven months between Carillion’s major profit warning in mid-2017 and its eventual collapse did not feature a significant day-to-day involvement of external turnaround specialists. It beggars belief that the full picture of woe was not known to the board some time before this.

Mind the gap

Large UK companies with pension shortfalls of the order of Carillion’s £587m should brace themselves for uncomfortable questions from creditors and shareholders. The Pension Protection Fund (PPF) has taken on the liability, which it believes could be nearer to £900m. That would make the PPF’s claim on Carillion’s assets almost as large as the collapsed company’s debts. 

Pensions consulting firm Hymans Robertson estimates that the FTSE350 has unfunded pension commitments of approximately £85bn. By contrast, the PPF is only a small lifeboat, with £30bn of assets and a £6bn surplus. Directors’ bonuses and shareholders’ dividends were put first by Carillion’s board.  Expect other CEOs and CFOs to come under fire.

Just having a look, thanks

UK retailers fear a chill wind blowing towards the High Street. January’s CBI Distributive Trades Survey of 107 chains showed a balance of only 12% reporting in increase in monthly sales volumes, against expectations of 12%. Orders placed with suppliers fell, against forecasts of growth.  Comparing the numbers with seasonal norms, 9% of retailers reported that their volume of sales for the time of year were good, whilst 25% said they were poor, giving a rounded balance of -17% – the lowest since July 2013.

Footfall is less of a problem than conversion of sales in-store. By contrast, internet sales rose 55% against the same month last year. The trend for young consumers to window shop before ordering online, often from another retailer, seems to be crossing generations.  However, there is more to the high street’s nervous outlook than a shift from offline to online. Low wage growth and continuing inflation worries are squeezing disposable incomes. For the retailers, currency factors and business rates are piling on the woe. Fashion group East entered administration this month, while furniture chains Feather & Black and Multiyork collapsed in November. The weighting of a challenging Q4 2017 pushed the annual total of retail failures to its highest in five years. 2018 is expected to be worse.

Not sick; merely the less-well man of Europe

The weakening outlook will motivate the Bank of England’s interest rate setters to keep the base rate at 0.5% when it meets in mid-February, say most economists. Even at the close of 2017, many of the same observers had speculated that the strength of the manufacturing sector and record levels of employment would trigger a series of rate rises this year. One month into 2018, there is a growing consensus that more than one rate rise is unlikely and that it will almost certainly not be until Q3.

The World Economic Forum in Davos started on an optimistic note, with the IMF predicting world GDP growth of 3.7% in 2018, still buoyed by India and China. However, the greatest improvements are set to be in the slower-growing developed world: the US is forecast to grow by 2.7% this year, boosted by stronger investment prompted by Trump’s corporate tax cuts. The Eurozone’s 2.2% is better than originally predicted, while the UK feels as if it is bringing up the rear with 1.5%.

The rising tide of global recovery has lifted all boats, as reflected in UK exports and stocks of finished goods. It is the main reason why the country’s worst economic fears have not been realised in the aftermath of the Brexit vote. Yet three factors seem likely to dampen growth in the foreseeable future: lack of consumer demand at home; a continuing skills shortage cited by employers as a brake on productivity; and a worldwide perception of uncertainty around the UK economy until Brexit is resolved.

Can BINO be dandy?

Uncertainty is compounded by the still unclear timeline on Brexit. If UK citizens feel it is taking forever, how must it appear to our trading partners, particularly outside Europe? Mark Carney, the Bank of England governor, says the 2016 vote has already cost the UK £20 billion in forgone GDP. In ostensibly seeking to minimise further economic disruption, the Chancellor, Philip Hammond, has said he wants the UK and the EU to move “hopefully very modestly apart”. Hardline Brexiteers accuse Hammond of supporting ‘BINO’ – Brexit In Name Only. Britain might move outside the customs union and the single market, while staying close to the European economy to which it has been historically aligned.

The majority of large companies in the UK, not least those that export, have been vocal remainers. Their trade body, the CBI, is possibly more BINO than Hammond, advocating staying in a customs union with a single set of tariffs for goods imported from outside the EU, while trade is tariff-free trade within it. The motor and aerospace industries in Europe are good examples of ‘ecosystems’ where components come from many different countries before being assembled in the UK, Spain, Germany or elsewhere.

A ‘hard’ Brexit, with no trade deal cemented with the EU by March 2019 or the end of an agreed transition period, would mean reverting to World Trade Organisation rules between trading partners with no free trade agreements. The Centre for Economic Performance estimates that a “No deal, WTO rules only” scenario would reduce the UK’s trade with the EU by 40% over ten years. The immediate impact of a lurch from EU rules to WTO could involve even greater falls. The government’s stated ‘safety net’ of simply replicating the schedules of the EU to smooth the transition makes Brexit feel even more like a bungee jump, bringing the UK repeatedly in and out of Europe’s trade orbit, before leaving it dangling.  Again, for the time being, the only certainty remains uncertainty.