U.S. recovery will boost corporate Canada

Corporate Canada can capitalize on the U.S. economic recovery, says CIBC World Markets.

The performance of the bank’s Composite Indicator of Corporate Canada’s Strength index suggests, “It’s widely expected that stronger growth in the U.S. next year will have an upside benefit for Canada, [but] what might surprise many is how quickly and significantly corporate Canada will ramp up spending to capitalize on the…rebound in global demand.”

What’s more, Benjamin Tal, deputy chief economist at CIBC says on average, a 1% change in U.S. growth has led to a full three-percentage-point change in capital expenditures by Canadian corporations.

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And during periods of high-index readings like we have currently, the same increase in U.S. demand has translated into 4% 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,” says Tal. “Given the highly elevated level of our index, the ability of Canadian corporations to respond to improving U.S. demand has never been better.”

He adds, “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.”

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CIBC Economics is calling for the U.S. economy to expand by 3.2% in 2014—more than double the projected pace in 2013—with the global economy growing by 4% next year.

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.

In fact, 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, says Tal. At $5.7 trillion, it is at a near-record high of 15% relative to assets, and 28% relative to credit.

He notes 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 Tal.

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“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,” he adds.

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,” says Tal.

In fact, “only 3,150 firms declared bankruptcy during the year ending June 2013, 8% below the rate seen in the same period last year, and less than half the average level of the past twenty years.

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“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 Tal notes that the profit margin has been trending downward in recent quarters. It stands at 6.5% and is a full point below the level seen a year ago.

A similar trend can be seen in return-to-equity, which at 10% is two points below the rate seen a year ago but still roughly in line with its long term average.