New composite indicator points to 8 per cent growth in business investment

TORONTO, March 27, 2012 /CNW/ - Corporate Canada is in better shape than it was before the recession, and its strong financial health should help it weather any short term challenges and take advantage of growth opportunities, finds a new composite indicator developed by CIBC World Markets Inc.

"It's encouraging that a health check on Canada's corporate sector shows businesses across the country passing with flying colours," says Avery Shenfeld, Chief Economist at CIBC, who co-authored the report with Benjamin Tal and Andrew Grantham. The CIBC indicator, which tracks corporate performance back to 1990, has never been higher and is now 1.36 standard deviations above its long-run average.

"History points to a solid medium-term outlook when the various indicators in our composite are in a position of strength," adds Mr. Shenfeld. "In those periods where our indicator has been lower than its long-term trend, growth in business investment has been broadly stagnant. In contrast, those occasions when the indicator has been higher have seen investment growth average over eight per cent. Corporate Canada has never been in a better position to deal with downside risks and fund investments in growth sectors."

Mr. Shenfeld, who released the report at a Symposium on Canada's 50 Best Managed Companies, notes that the strength in Corporate Canada runs across sectors and the indicator was not driven up by the performance of one or two major industries. In fact, improvements in cash positions and profit margins over recent years are more impressive when the bustling energy sector is excluded.

The CIBC composite indicator of corporate strength looked at nine key measures. It found that debt-to-equity ratios for 2011 were lower than their respective long-run averages in 8 out of the 12 sectors examined. Cash holdings have also grown to levels that provide a considerable cushion against either a new disruption in the availability of financing or a downturn in earnings. As a proportion of corporate credit, cash holdings languished around the 20 per cent mark throughout much of the 90s before gradually increasing. Despite taking a small hit during the recession, cash holdings relative to credit have risen to an all-time high of nearly 60 per cent.

Profit margins at Canadian companies have, on average, been on a broadly upward trend since the early 1990s. After falling back during the recession, margins have subsequently risen again to within shouting distance of their 2008 peak. A similar trend can be seen in the return on equity, which having taken an even greater hit during the recession, has also quickly bounced back.

"Interestingly, the rebound in return on equity has been held back somewhat by two of Canada's strongest growing sectors—oil & gas extraction and construction," says Mr. Shenfeld. "In both of these areas, returns on equity during 2011 were lower than their long-run averages, with the broad results for energy likely capturing the impact of weak natural gas prices. In contrast, the accommodation & food sector posted a return on equity three times its historic average."

He notes that heavy cash holdings and conservative balance sheets could represent management pessimism over the business climate ahead. But while business confidence waned a bit in 2011, it finished the year still slightly above its long-run average. In addition, at only 3 per 1000, the business bankruptcy rate is the lowest in at least 30 years.

"Given all the shockwaves and negative headlines on the economic picture in the past year, the fact that confidence held up above-trend is actually quite remarkable. With concerns surrounding Europe abating, and the U.S. showing improved growth, it's likely that fresh measures of business sentiment will show a rebound."

The new CIBC composite indicator also factors in the export diversification indices created by the bank. These suggest that, while some Canadian exporters may be feeling the pain of a strong loonie, overall, exporters are gaining strength through an increased diversification in the countries and commodities with which they trade. "During the 1990s, Canadian exports became narrowly focused on the U.S. This trend began to reverse at the turn of the new millennium, and has continued to improve. Indeed, rising exports to developing countries in recent years have seen our diversification index improve above its 1990 starting point and maintain an upward trajectory."

The ability of exporters to diversify the commodities they trade has also improved over the past decade, though the trend here has been less impressive. Canadian exports, in real terms, are no longer as heavily dependant on oil, although diversification is not quite back to levels seen in 1990.

While economic growth looks to be still only moderate for now, Mr. Shenfeld believes Canadian companies that were well positioned to cope with the financial crisis are now at a point where they could begin to reap the benefits and drive economic growth in the years ahead.

About the CIBC Composite Indicator of Corporate Canada's* Strength

CIBC's Composite Indicator of Corporate Canada's* Strength uses nine key macroeconomic measures to calculate the health of Canada's corporate sector. These measures normalized with respect to their long-run averages and standard deviations, and an unweighted average is taken.

The macro variables used to develop the indicator are:

• Debt-to-equity ratio;
• Cash-to-credit ratio;
• Profit margin;
• Return on equity
• Return on capital
• Export diversification - Commodities
• Export diversification - Countries;
• Business bankruptcy rate;
• Business confidence.

* Non-financial corporate sector

The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/corp_canada_health_check.pdf

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