Cover Story : On The Brink – Poised on the Edge

The full effects of the global economic crisis have yet to hit home in New Zealand with the combined revenue of the country’s top 200 companies managing to rise creditable 7.9 percent this year. While next year’s balance sheets will probably reflect more gloom, this year’s Top 200 companies took in $143 billion, an increase from last year’s group which had combined revenue of $133 billion. The bottom line for making the Top 200 ranking has risen $11 million over the past 12 months to sit at $131 million revenue in 2008.
That said, signs that all is not well are coming through in collective drop in profits. Last year’s figure of $10.4 billion has dwindled to $6.8 billion. And although Telecom’s 2007 abnormal of $2.1 billion from the sale of the Yellow Pages did skew things somewhat last year, 2008 profits are still lower. Fonterra, with by far the largest revenue of any company, shows profit this year due to IFRS accounting changes.
The list shows that New Zealand companies have built up their asset bases over the past year (up 18 percent), however some of that can probably be attributed to the effects of adopting new International Financial Reporting Standards.

Top performers
Fonterra retains its number one spot by country mile although the Top 10 has seen some change this year.
Most significantly, Graham Hart’s Rank Group acquisition of Carter Holt Harvey sees that company disappear from the number seven spot. Rank Group’s financials are not released publicly. Market and investor favourite Fletcher Building hangs onto its number two spot for the second year as Jonathan Ling’s leadership and vision continues to please and to produce, notwithstanding concern over the 2007 purchase of US based Formica, the timing of which, in retrospect, appears unfortunate.
Elsewhere on the list, last year’s Company of the Year, Infratil, has moved up 18 places to rank 23rd this year. The company recently reported 23 percent rise in operating profit to $203 million for the six months to September 30, showing it is weathering the economic storm safely. Company boss – and the 2007 Executive of the Year – Lloyd Morrison was reported as saying he is taking conservative view of the economic outlook and expects the meltdown will continue to dominate for at least the next six to nine months.
Ebos Group, this year’s ‘Most Improved’ company, had massive leap from 100th to 30th in the rankings largely as result of its purchase of pharmaceutical, distribution and logistics business PRNZ. It was bold move for the healthcare company and one which saw after tax profit rise by 61 percent.
This year’s list shows significant revenue increases for the energy companies but without correspondingly sized profit increases. All have moved up the rankings. Adjustments for IFRS may have affected some of the profit results and the overall returns on assets are not high.
The country’s banks might find it hard to explain their figures though. As usual the banks are big profit makers, and report significant return on equity, which could lead customers to question the banks’ reluctance to pass on the full effect of RBNZ rate cuts to them. Sure overseas borrowing is still hard but isn’t it time our banks paid social dividend and put up with trimming of profits? They may have shareholders to appease but haven’t they caught on to triple bottom line reporting where financials are not the only bottom line.

Sectors
Looking at some of the sectors the Top 200 companies inhabit reveals differing effects of the global crisis.
• Retail: This sector is showing signs of slowdown and has had double whammy from falling sales and rising costs. While the pending tax cuts and lower interest rates should loosen consumers’ purse strings somewhat, trading conditions are likely to remain weak for some time yet and many of the retail companies on this year’s list face tougher times ahead.
• Manufacturing: Domestic demand is likely to slow further in 2009 putting dampener on fairly solid early part of this year. Ongoing higher costs are also likely to impact the profitability of firms in this sector.
• Agriculture: Fonterra’s reduced payout forecast has hit optimism in this sector. Sluggish foreign demand has depressed commodity prices and while the lower currency has helped shield exporters from lower prices, things are unlikely to look up in the near future.

Deloitte chairman Nick Main says the impact of the change to International Financial Reporting Standards is difficult to isolate in these results. In part this is because not all companies are converting in the same year and in part because the effect of the change will be specific to each entity. “However it is likely that profits are more volatile,” he says. “The good news is that with its focus on fair value for balance sheet items and the requirements to look for asset impairment the balance sheets are likely to be more reliable indication of the business’ asset strength.” Main said disclosures have also been extended so investors are now more able to make informed decisions. “In these circumstances the strength of the balance sheets of the top 200 companies augurs well for them surviving the challenges ahead.”

Economy
As usual, there are two sides to the economic story. First the good news: lower New Zealand dollar means our exports are more competitive; lower interest rates bring cheaper borrowing costs; and retracting petrol prices are taking some of the pressure off inflation. The bad news: weakening confidence and reduced consumer spending; reduced demand from overseas for our exports; the housing price slump; and potential employment cuts. Two sides, but the score currently sits at one:nil to the bad news.
According to an economic outlook released last month by Goldman Sachs JB Were, the local recession will continue to deepen until mid 2009.
Large external imbalances, falling commodity prices, domestic recession and deep rate cuts mean the New Zealand dollar is likely to depreciate further and the timing and pace of New Zealand recovery will hinge on RBNZ policy response, the pace of labour market adjustment and the global economic cycle, it said.
And Westpac chief economist Brendan O’Donovan believes any substantive economic recovery for New Zealand is unlikely before 2010.
“The housing correction has further to run and unemployment will rise further. But most importantly, the world is going through massive de-leveraging process. As one of the most indebted nations in the world, New Zealand will not be immune.”
Globally, O’Donovan says, to get grasp on the “how long” of this downturn, it’s useful to look at history. Since the Second World War, the average United States recession has lasted 10 months. Recent IMF work has examined recessions around the world and has highlighted that those preceded by financial crises are deeper and longer lasting. Also, recessions that are centred on consumers restoring their balance sheet tend to be longer lasting.
In light of this, the prognosis is that the current downturn will in all likelihood be more pronounced than the norm and may deliver up to or over three years of deeply sub-trend growth. That is akin to the 1982 global downturn where growth in the developed world was going backwards and developing economies were spluttering forward on one cylinder.

So what can be done locally to minimise the effects?
New Zealand Institute boss David Skilling and NZX head Mark Weldon released joint paper in October seeking debate and action on the country’s economic future.
“We are facing global economic crisis that will hit New Zealand very hard. The New Zealand economy is at the top of the cliff with dive to execute. That dive can be swan dive – elegant and strong and from which we emerge with real energy – or it can be brutal and painful belly flop,” the pair said.
“In our view, the New Zealand policy response to date has been too weak and inadequate to provide confidenc

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