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.
The CIBC composite indicator of corporate strength looks at nine key measures to calculate the health of Canada’s non-financial corporate sector. These measures are 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; and
- usiness confidence.
According to CIBC, debt-to-equity ratios for 2011 were lower than their respective long-run averages in eight 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% 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%.
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 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.
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.
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, 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.