Corporate Canada poised to take advantage of strong U.S. economic recovery in 2014: CIBC report

Canadian businesses to significantly ramp up capital investment

TORONTO, Oct. 21, 2013 /CNW/ - Corporate Canada has never been in a better position to capitalize on a U.S. economic recovery, finds CIBC World Markets Inc. latest Composite Indicator of Corporate Canada's Strength.

"While it is widely expected that stronger growth in the U.S. next year will have an upside benefit for Canada, what might surprise many is how quickly and significantly corporate Canada will ramp up spending to capitalize on the long awaited rebound in global demand," says Benjamin Tal, Deputy Chief Economist at CIBC.

Using the bank's Composite Indicator of Corporate Canada's Strength, he finds that, while softening somewhat recently, the index is still hovering around an all-time high and is almost a full point above its long-term average. "That's important since the higher the level of our index, the more responsive corporate Canada has been to a shift in U.S. demand."

Mr. Tal notes that, on average, a one per cent change in U.S. growth has led to a full three-percentage-point change in capital expenditures by Canadian corporations. However, during periods of high-index readings like we have currently, the same increase in U.S. demand has translated into a four-percentage-point acceleration in capital spending by Canadian companies.

"The response by Corporate Canada is directly linked not only to the speed of the recovery south of the border, but also to its financial position at the eve of that acceleration," he says. "Given the highly elevated level of our index, the ability of Canadian corporations to respond to improving U.S. demand has never been better.

"What's more, this is not a tale of one or two major industries that biased the aggregate results. The index performance is widely based. In fact, improvement in key measures such as cash position and profit margin in recent years actually appears more impressive when the mighty energy sector is excluded."

CIBC Economics is calling for the U.S. economy to expand by 3.2 per cent in 2014, more than double the projected pace in 2013, with the global economy growing by four per cent next year.

Mr. Tal cites the prudent approach by corporate Canada before, during and after the recession for its strong position. Corporate debt-to-equity ratio is currently at an all-time low, recently falling below pre-recession levels. Its current ratio of less than 0.9 is a full one-and-a-half points below its long-term average.

The strong cash position held by Canadian firms is another factor contributing to the elevated level of the index. At $5.7 trillion, it is at a near-record high of 15 per cent relative to assets and 28 per cent relative to credit. He notes that the trajectory of the increased cash position is not something new but simply a continuation of a long-term trend and in line with prior-cycle normal business practice.

"While businesses have increased the share of assets they hold in cash, they, at the same time, reduced the share allocated to other current assets," says Mr. Tal. "Those largely comprise account receivables and inventories, which have been pared to less costly levels through improved logistics, manufacturing integration and better management information systems. We view the elevated cash position as an increase in the relative share of a more productive asset—one that can increase firms' accessibility to lower cost financing."

Another notable example of corporate Canada's strength is the current level of business bankruptcies. "Regardless of how you measure it, the number of business bankruptcies in Canada is at a record low," notes Mr. Tal. "Only 3,150 firms declared bankruptcy during the year ending June 2013, eight per cent below the rate seen in the same period last year, and less than half the average level of the past twenty years.

"And despite the fact that today there are close to 30 per cent more businesses in the Canadian economy than in the late 1980s, there are 50 per cent fewer business bankruptcies. Accordingly, at only three, the estimated number of bankruptcies per 1,000 businesses is by far the lowest on record."

However he notes that profit margin, while still a full two points above its long-term average, has been trending downward in recent quarters and at 6.5 per cent it is a full point below the level seen a year ago. A similar trend can be seen in return-to-equity which at 10 per cent is two points below the rate seen a year ago, but still roughly in line with its long term average.

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. At present the composite index is 1.4 standard deviations above its long-run average.

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.

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/corpcanadahealth_check13.pdf.

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.

SOURCE: CIBC World Markets

Benjamin Tal, Deputy Chief Economist, CIBC World Markets Inc. at 416-956-3698, [email protected]; or Kevin Dove, Communications and Public Affairs at 416-980-8835, [email protected].