Majority of the largest companies in Asia posted higher growth in 2014. Though most of them eventually expected revenues to grow during the year, profits were not as expected and falling. The proportion of Asia's Chief Financial Officers (CFO) who expected profits to grow has dropped to 60 per cent down from last year. The trend suggests that it is getting tougher to extract value from revenue growth. It is gradually coming into reality that Asia is no longer the high growth and high earnings market that it used to be. In a post-Asian Miracle era, CFOs in Asia are now thinking about strategies to improve operational efficiencies to drive profitability.
The recent results of 2014 Asia CFO Outlook survey endorse the commonly-held idea that Asia will provide a wellspring for global economic growth for years to come. But it also reveals that with growth comes a set of risks that each company faces in each sector. And in each nation-across the incredibly diverse range of business cultures, economic systems, and political structures in the nations and territories polled in this survey-the CFOs will have to work increasingly hard to capture that growth and turn it into value.
The number of CFOs in Asia who expected profits to grow is also very high but yet has fallen to 60 per cent from last year's 65 per cent. The 'value gap' between those who expect revenues to rise and those who expected profits to rise is 16 percentage points, up from 7 last year-suggesting that it is getting tougher to extract value out of revenue growth.
"We are going through a significant change... a shift in revenue mix causing some margin pressure across Asia-and the world." Pressure on margins is driving Asia's CFOs to focus on raising profitability through core disciplines like operational efficiencies (picked by 45 per cent) and better working capital management (41 per cent). But a greater proportion, 51 per cent, say they will seek to build profitability through the use of technology and automation, such as customer relationship management programmes, better management and supervision of supply chains and forecasting.
A clear indicator that pressure is building on margins is evident across several Asian markets. In Australia in 2014, 77 per cent of CFOs expected revenues to grow, while 67 per cent expected profits to grow leaving the margin at 10 percentage points. This gap was more slender at 6 points in 2013. In Indonesia, the gap is 10 points in 2014 and was 7 points in 2013. In the Philippines, the difference year-on-year was much more dramatic: 30 points in 2014 versus a mere 2 in 2013. In South Korea, it is even more: 36 points in 2014 and only 4 in 2013. The year 2013 was a turning point for Japan's economy, but there too the margin gap is expanding: 27 points in 2014 from 7 a year before.
At the backdrop of unique challenges faced by each economy, common concerns surfaced across the region. In China, as the government rebalances the economy's drivers, growth slows and risks mount in the banking system. In Japan, businesses are expanding revenues under the government's policy to hold down the yen's value and its products become more attractive in global markets, but costs associated with the weaker currency were rising too. In Australia, the easing off the Australian dollar due to resources boom raised the weakening and costs. In the Philippines, companies are expanding as the economy grows, but what the OECD calls 'structural challenges'-from infrastructure woes to gaps in the education system, and a shortage of public and private investment-appear to be making it more difficult to extract value from that growth. The same could be said for other emerging markets in Asia. Competition is building. Consumers are becoming more sophisticated, demanding more. The cost of capital looks set to rise Uncertainty exists as the US weans itself off easy money, a process that will reverberate throughout markets this year. Political change is rippling through the region.
This environment was precisely the kind in which the classic values associated with the CFO position everywhere were put to test: a drive for financial accountability, a conservative view toward risk-taking, a strategic understanding of the business and a grasp of the risks associated with expansion. In such an environment, putting these values into practice may create competitive advantages. The trends also emerging from the survey show that companies across Asia endorse avenues to growth in which CFOs can make a powerful difference.
Organic growth is favoured over the costly mergers and acquisitions (M&A) process. Goals for M&A itself are aligned with goals that produce organic growth once an asset is in hand, such as acquiring new technology to grow and enhancing production capabilities. The preferred roads to profitability include using technology and better supply chain management to extract value from expanding sales and operations, better management of working capital and operational efficiencies. For financing, the focus is away from long-term debt, a preference for bank loans and a drive to generate internal funding. The arena for the test of these skills exists everywhere in the region, but companies see the greatest opportunity in Southeast Asia-including the 'frontier' economies of Myanmar, Cambodia and Laos-and India. In gaining firm operational ground in these markets in 2014, companies were not counting on organic growth forever. As capital costs rise, companies that have taken on leverage will struggle, divestment will accelerate, asset prices will come down and a livelier M&A scene will emerge. But companies have to put themselves in a solid position to take advantage of these trends. The results of this survey suggest that solid foundations are being established for a new phase of growth in Asian markets. Organic growth is the number one way CFOs intend to use surplus cash, while just 24 per cent will spend it on M&A. Some 62 per cent of CFOs say that they did not have M&A plans in 2014, around the same proportion as in 2013. Of those that do, the most popular market is Southeast Asia-ranked first in 2014 from second last year.
In Southeast Asia, there were interesting investment opportunities, but asset values were still high. Some companies took on a lot of leverage. Some have had to de-leverage, and assets that were not on the market were supposed to be lost on sight. On the other hand, a substantially higher proportion of multinational CFOs (66 per cent) expected profits to grow in 2014, compared to CFOs from local companies (54 per cent). This is despite similar expectations for revenue growth in each group-suggesting local companies faced even tighter margin pressure in 2014. A market economist in Asia was bold enough to opine that 'for eight years, our ambition has been to grow in the region. We have invested and expanded. This region should be growing for another 20 years."
Some 41 per cent of CFOs expected that companies are likely to adjust their capital structure to decrease the weighting of long-term debt. In terms of the type of financing, bank loans are the stand-out preference, picked by 57 per cent. For many, internal funding sources are greatly preferred to any other means of finance.
Meanwhile, around a third of CFOs (31 per cent) also expected capital costs to rise. Just 35 per cent plans to raise capex, down from 46 per cent in 2013. However, South Asian economies are uniquely advantaged compared to businesses that require capital to sustain growth. Trend shows that it will become increasingly harder to access capital and at a higher cost.
Dr Muhammad Abdul Mazid is Chairman, Chittagong Stock Exchange and Chairman, South Asian Federation of Exchanges. [email protected]
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