Buchler Phillips Quarterly Bulletin No.9

Rooting for the captain Down Under

England cricket captain Joe Root has many qualities that headhunters in the business world would struggle to find in a single candidate: talented, confident, tactical, determined to a degree just the right side of stubborn and ready to turn on the aggression when needed. But sometimes leading from the front can feel uncomfortable and require greater flexibility than first imagined. As England prepares its campaign to retain the Ashes in Australia later this year, Root’s side has lacked a high class international batsman in the most important position in a Test match XI: the No.3, the man who goes in first wicket down. Despite coaches, pundits and past captains calling for Root himself to step up, he has been consistently reluctant, prepared for the less-fancied James Vince to be pencilled in.

Widely seen as Root’s toughest battle yet – and by some margin – the Ashes could reinforce for the young captain the need to consolidate his leadership and grip the toughest hands-on jobs himself. If he succeeds, he will provide yet more inspiration for the business world about harnessing resources and scaling new heights of preparedness for whatever uncontrollable factors the next few months will bring.

Guide Me O Thy Rate Increaser

Under Mark Carney, the Bank of England has become a master of signalling higher interest rates without delivering them. Launching the BoE’s version of forward guidance within a month of becoming Governor in July 2013, Carney said rates would stay at their record low until UK unemployment fell to 7%. He expected it to take three years, but the jobless total shrank to that level in just six months. In February 2014, the BoE switched its focus from unemployment to various measures of spare capacity in the UK economy. Rate hikes would be “gradual and limited”. Four months later, Carney spoke of rises “sooner than the market expects”.

As 2015 brought falling inflation, lower oil prices and low wage growth, the Governor talked of a rate decision coming into “sharper relief” around the end of the year. But wage growth and oil prices dipped yet again. The June 2016 Brexit vote prompted a rate cut to 0.25% as a stimulus measure against a recession that never happened. Then, no sooner had markets begun to expect unchanged rates until 2019, than the BoE said in September 2017 that price pressures made rate rises likely “over the coming months”. A Reuters poll of 50 economists on 20 September showed 31 respondents expecting a rise to 0.5% on November 2 – although 35 said it would be a policy mistake.

The Consumer Price Index jumped 2.9% in August, from July’s 2.5% rise, as the sterling cost of imported food and clothes continued upwards. The BoE itself expects the CPI to break through 3% in October, with a post-Brexit fall in migrant labour likely to fuel wage growth longer term. Carney continues to pursue his rate rise narrative, but the benefits remain unclear to most.

Shop til you drop

The CBI’s Distributive Trades Survey on September 27 showed a sharp rise in UK retail sales between August and September. The balance of the 20,000 outlets reporting a sales rise over a sales reduction was 42%, against 6% in the previous month. Clothing retailers and grocers were the best performing sectors. As well as fanning belief that base rates will rise in November, economic commentators collectively expect GDP growth to expand to 0.4% in the third quarter to September, from 0.3% in the second quarter. The trend is clearly defying low wage growth, while suggesting that consumer spending may be moving away from the ‘outings and experiences’ profile of the last 12 months and back to more traditional purchasing patterns.

Brexit: the only certainty is uncertainty

The lack of visibility in economic forecasts, compounded by contradictory quarter-on-quarter statistics and anomalous ‘flash in the pan’ recoveries, only serves to mirror how little we know about the shape of Brexit and its longer term impact on prices, jobs and growth – even 15 months after the UK’s referendum. While the UK’s negotiators continue to fixate on the cost of the divorce bill – discussed in our last edition – the backbone of the country’s economy, Small and Medium Enterprises (SMEs), are increasingly fearful for their prospects.

SMEs employ 60% of private sector workers in the UK. New research from the Federation of Small Businesses, surveying more than 1,200 of its member CEOs, shows that their confidence has hit a new low since the Brexit vote. In fact, 13% are considering downsizing, selling or closing their business all together. At the same time the number of firms reporting higher revenues has hit a four-year low. Only 27% of small firms expect to increase investment in the next three months, a 5% drop compared to the previous quarter.

Bosses blame the rise of operating costs, which they say are 70% higher than this time last year, and market uncertainties. Of the people polled, 70% are now facing higher operating costs than they did at this time last year. Consumer-facing businesses in sectors such as independent retailers and entertainment have a particularly bleak outlook. The benefits to exporters of a weaker pound affect less than 20% of SMEs, compared to 40% of large UK companies.

The long term detail, rather than the short term divorce bill, will be crucial to restoring the fortunes of this important segment of the UK economy. Access to finance is key and this would not be helped by a botched withdrawal from the European Investment Fund. SMEs are also hoping for constructive changes in the way they are taxed and a comprehensive free trade agreement to boost the proportion of exporters in their ranks.

Not too hot, not too cold

If Goldilocks ever wearied of testing porridge, what would she make of the UK’s property market? Brexit’s complexity is set to take its toll on central London’s luxury housing sector, in recent years a top destination for French tax refugees, as well as traditional high net worth property investors. Savills predicts a 4% price fall for 2017, followed by possibly three flat years before a strong bounceback in 2020. The reduced forecast is not surprising, given that

the number of £1m-plus properties where the asking price has been cut nearly doubled in the first half of 2017 from the same period in 2016. While the world’s largest banks continue to think aloud about moving their European HQs to remaining EU countries, London’s top-end residential market will remain fragile.

The capital’s commercial market has been much more resilient, helped by an influx of money from China and Hong Kong seeking to invest in high-end assets. In addition, the trend for informal serviced offices has seen that segments largest operators lease new space. In the first half of 2017, Chinese and Hong Kong investors pushed a record £4bn into London commercial real estate, helping to drive total investment in the city to £12bn, according to data CBRE. That includes £1.15bn paid for the “Cheesegrater” skyscraper by Hong Kong-listed CC Land. The deal was exceeded by Lee Kum Kee’s £1.3bn purchase of the nearby “Walkie Talkie” building.

Christmas won’t be cancelled after all

In one of the restructuring industry’s highest profile cases of the last 12 months, Toys R Us filed for Chapter 11 protection in September. Cursed with high real estate costs and fierce online competition, primarily from Amazon, the retailer has $4.9bn in debt, $400m of which has interest payments due in 2018 and $1.7bn of which is due in 2019. In the third largest Chapter 11 filing in US retail history, Toys R Us has already secured a commitment from some lenders, including a JP Morgan-led syndicate, for over $3bn in debtor-in-possession financing. The restructuring gives Toys R Us the group financial flexibility to continue its turnaround ahead of the crucial Christmas trading period. Chapter 11 has effectively ringfenced the US and Canada operation and the Europe and Asia operations continue to trade normally. 

Amid fewer column inches, but no less important on the turnaround scene, Seadrill one of the world’s largest offshore drilling companies, filed for bankruptcy in September after nearly all of its banks agreed to support a plan to inject $1bn in new capital and all but wipe out existing shareholders. Controlled by billionaire ship owner John Fredriksen, Seadrill has struggled ever since the 2014 oil price crash and has been searching for a deal to restructure almost $10bn in debt. The proposal would see $5.7bn of bank debt extended by about five years. Holders of $2.3bn in bonds would be offered about 15% of equity in the newly restructured company. Existing shareholders would receive just 2%. Seadrill’s bankruptcy is not the only major upheaval in the offshore drilling market. Hercules and Paragon have both filed for bankruptcy while there are signs of consolidation among a number of the remaining operators.