|Naveed Sultan |
Global Head of Treasury and Trade Solutions, Citi
Spurred by historically low global interest rates and corporate spending in excess of operating cash generated, the net debt borrowed by large corporations has increased significantly over the past several years. As of 3Q 2017, S&P 500 non-financial companies added $1.2 trillion of net debt relative to year-end 20111. Today, the majority of corporate debt is fixed. Still, as companies refinance a larger borrowing position in a rising rate environment, finding access to funding that is less sensitive to rates may become more valuable.
At the same time that invested capital is rising (driven by growth in both net debt and equity), large US companies have faced strong headwinds in growing their top line revenue. In the 12 months ending 3Q 2017, 65% of S&P 500 non-financial companies reported lower growth than they did in 20111a. Despite stable profit margins over the past several years on average, for most companies profit growth is not keeping pace with growth in invested capital. As a result, return on invested capital (ROIC) - a key performance metric for equity investors - could be under pressure. While a reflating world economy and US tax reform is expected to help corporate profits, ROIC may continue to be impacted by growth in corporate balance sheets and invested capital - and the ROIC challenge could likely remain.
Other changes, such as accounting reforms for the treatment of leases may put further pressure on corporate balance sheets, reported leverage and capital returns going forward.
As a consequence, improving asset efficiency and reducing reliance on external capital remains a high priority for corporates looking to improve returns, increase flexibility and reduce risk. Not surprisingly, more companies may be looking to implement strategies that reduce their need to borrow and that improve utilization of existing capital tied up in the working capital cycle. This can be particularly important in de-risking balance sheets across jurisdictions for multinationals. With an integrated global suite of working capital strategies supported by valuable insight, Citi is positioned to help corporates increase their sources of liquidity in the changing environment.
Working capital efficiencies are a key way to respond to these challenges
As of 3Q 2017, the median non-financial company in the S&P 500 had net working capital equal to 14% of total invested capital1b. For this reason, improvements in working capital efficiency can have a meaningful impact on asset efficiency.
As is frequently the case, working capital can be trapped within an enterprise for weeks. Some 53% of corporate America faced longer cash conversion cycles as of 3Q 2017 than in 20111c. With ROIC under pressure, there may be a significant opportunity to free up cash in order to improve returns on capital for shareholders and fund desired strategic CapEx projects and investments.
Corporates and their trading partners can rely on Citi, as one of the world's leading Working Capital Finance banks, to help achieve greater capital efficiency through accelerated sales and margin performance. Combining a strong track record, a broad array of capabilities, and most importantly, advisory experience gained from working closely with leading companies around the globe, Citi is one of the market leaders in supporting client needs across days payable outstanding (DPO), days inventory outstanding (DIO) and days sales outstanding (DSO):
- Days payable outstanding: Supply chain finance allows buyers to continue to support their suppliers in virtually every corner of the globe. Citi has a unique legacy of more than 15 years of supply chain finance experience, supporting more than 2,300 buyers and 70,000 suppliers to extend DPO and extract cash from the working capital cycle. Suppliers, particularly in emerging markets, can access a valuable and reliable source of capital, which is independent of their own credit rating, their country's credit cycle and possible shocks from the local banking sector. This allows the supplier to access consistent and relatively cost-effective capital. At the same time, buyers are better able to negotiate longer payment terms without an adverse financial impact on the supply base, thus helping to mitigate the risk of supply chain disruption. Another innovative supply chain finance option is dynamic discounting. By utilizing fintech technologies, Citi is working to apply the buyer's own excess short-term cash to fund early payment of approved supplier invoices. This can be a win-win for both buyer and supplier as it can help to achieve better discount returns and EBITDA improvements of a company's balance sheet.
- Days inventory outstanding: As corporates make strategically important large purchases of valuable commodities at key price points, it is critical to be able to buy and hold inventories without detrimentally affecting their working capital position. Citi has helped customers address this complex challenge by combining efficient supply chain strategies with a secured trade loan that enables corporates and their trading partners to manage future delivery at a pre-determined time. This program more effectively helps to manage raw materials and finished goods inventory under circumstances where high returns on invested or tangible capital are required.
- Days Sales Outstanding: As corporates strive for sales growth across the globe, they have become increasingly concerned that areas of their client base may experience an inability to access capital, particularly in emerging markets, which could become a growth inhibitor. Due to accounting changes in IFRS 15, that enable corporates to recognize revenue from long-term managed sales contracts, and changes under both U.S. GAAP and IFRS 16, that may make capital leases harder to keep off balance sheets - sales finance strategies have become far more attractive than ever before.
Citi considers itself as an innovator as one of the first to provide sales finance strategies, supporting over 1000 buyers in more than 65 countries and 25 currencies. Sales finance, also known as distribution finance, is a strategy helping accelerate sales growth by potentially increasing purchasing power. By offering structures to improve working capital, companies can improve the free cash flow of their clients through longer sales terms without negatively impacting DSO. In return for the longer terms, the buyer can accept higher sales volume targets from the customer.
Contract monetization programs also allow corporates to offer sales of multi-year contracts to further extend working capital. This can apply for managed service and bundled service contracts, which can allow their customers to turn large, single-period capital expenditures into multi-accounting-period operating expenditures. At the same time, this can help enable corporates to recognize the revenue and the free cash flow at the point-of-sale.
The right strategic banking partner can be crucial for optimizing working capital
Many corporates are realizing that a significant portion of their capital structure is tied up in supporting their working capital. This can create a drag on free cash flow and ROIC.
Finding the right banking partner can be crucial for optimizing working capital. Citi’s strategies across its Securitization and Trade groups, can help corporates to accelerate the repayment timeline on their receivables position. With a global network across nearly every jurisdiction in which corporates operate, Citi is aligned to help enable corporates to effectively de-risk balance sheets, improve free cash flows and return on capital.
1, 1a, 1b, 1c FactSet, Bloomberg, and Company Filings available as of November 2017