Treasury Practice

Defying gravity: financing growth strategies in a declining market

Published: Jul 2016
Vishal Kapoor, Asia Pacific Trade Head, Treasury and Trade Solutions, Citi

A strategic approach to financing growth is essential in today’s fiercely competitive global environment. What strategies are most successful for scaling up when the markets are falling?

Vishal Kapoor

Asia Pacific Trade Head, Treasury and Trade Solutions, Citi

Vishal Kapoor is the Trade Head for Asia based in Hong Kong, working with the Banking Group to expand trade business. Prior to this he was a part of the Leverage Finance and DCM team. He has a Bachelor of Technology from India’s National Institute of Technology, and a Master’s Degree in Business Management from City University, New York.

When economic growth stalls, businesses must react quickly or face an uncertain future. Whilst in many cases Asian economies are still exhibiting growth levels that their European counterparts can only dream of right now, the slowdown in growth is palpable.

China’s headline growth rates in recent years have often been in excess of 8% (they even scaled above 14% in 2007 following on from the all-time high of 15.40% in Q1 1993). Whilst its economy grew by an annual 6.7% in Q1 2016, compared to 6.8% in the previous period, this is still the weakest growth it has shown since Q1 2009. Indonesia’s GDP grew by 4.79% in 2015 but although this was slightly above expectations, it too marks the country’s slowest growth since 2009. Likewise, Vietnam’s economy expanded 5.46% year-on-year in the three months to March 2016, but this is slowing from the 7% growth seen in the previous period.

This story continues across many other countries in the region and the apparent slow reversal of growth expectation is enough to worry the markets. This creates a knock-on effect that only serves to exacerbate the commercial gloom. For the treasurer, the time is now to make some strategic changes and, for the wise incumbent, these changes should not only cushion the effects of slowing revenues and trade flows now but also act as a buffer for future market fluctuations.

Taking a new approach

Where companies got rather used to the high-growth environment, many allowed this to drive their corporate structure, with strong growth funding the business and the pressure on delivering operating efficiencies somewhat lower. Moreover, given the benign interest rate environment, most corporates took on more debt not only to fund higher growth but also to meet other strategic priorities including acquisitions, share buybacks and dividends. As growth stagnates, the expenses of running the business may no longer be in proportion with actual growth, explains Vishal Kapoor, Asia Pacific Trade Head, Treasury and Trade Solutions, at Citi. He urges businesses to acknowledge that it is unlikely that their ‘good-times’ structure, including potentially high debt levels, can be sustained as growth slows. Kapoor also advises that preserving debt capacity – which is curtailed in a weak growth environment – and finding alternate ways of improving cash flows becomes paramount in order to maintain the company’s overall financial flexibility.

However, he warns that the necessary response to a slowing of growth may not always be one that can be enacted at the press of a button. A company in the middle of a capital expenditure project, for example, will not easily be able to stop or reverse plans which were commenced during the economic heyday. Because operating costs are not generally driven by the same economic principles as sales growth, Kapoor observes that key metrics such as EBITDA may start to drop rapidly at the hands of the lag that exists between the implementation of improving measures, and those measures taking effect. Furthermore, where a high-growth environment has been assumed, support of the cash cycle has perhaps seen less of a focus – but as the outlook weakens and the top line becomes more volatile, pressure to revisit the working capital cycle increases.

Mutual support network

As the realisation hits home that growth is slowing, Kapoor strongly advises companies to embark on a strategic review of processes and operations, with the aim of re-aligning their business models to cater to the new normal. With cash flow falling away and reliance on cheap debt no longer sustainable, the need is to find new ways to rebuild and sustain growth, he says. The first major constituent of this undertaking is to eke out improvements in operating efficiency, looking at the entire working capital cycle. The second is to find new models of growth stimulation which, he suggests, may not come via traditional methods but instead be derived from the support of the company’s clients.

A fundamental change is proposed here: treasurers need to work a lot closer with the sales function and vice versa. The two are seemingly at the mercy of conflicting purposes: finance managers may feel that the issue of timely payment is never given enough importance in client discussions, whilst conversely sales managers may argue that credit constraints adversely impact relationships with clients – and seemingly never the twain shall meet. However, Kapoor believes and stresses that closer alignment between these two functions is possible and indeed beneficial. Treasury even has an opportunity to intermediate between sales colleagues and external banking partners, with treasury positioning itself as the means of facilitating revenue growth.

As an example of how this co-operation might be made concrete, Kapoor cites the formation within some forward-thinking companies of hybrid ‘sales finance’ teams, motivated to steer working capital and revenue issues in a new and positive direction.

Ideas in action

The customer benefit with such a setup may manifest directly through the in-house financing of purchases. However, suppliers could also exploit internal sales/finance collaboration by offering longer terms to customers, mitigating the risk of those terms by selling the receivables to its bank. By working in partnership with the finance team, Kapoor explains that the sales function can extend terms of payment without damaging cash flow. Companies can look to deploy these terms in conjunction with or in lieu of ‘other’ volume or price discounts to drive higher sales from its buyers. Such a move incentivises the buyer to purchase more as it reduces its working capital and also positively impacts its return on capital.

With the trend of extending terms taking place across most industry segments, Kapoor also notes that many industrial companies are purchasing high-value goods and services and pushing out payments for as long as 24 to 36 months. Corporates wishing to sell into this environment clearly face a dilemma. The desire – and even the policy conditions – that would allow a company to take such a risk would be unlikely in a buoyant market. As revenues begin to slip, the company has to decide whether to forgo that sales opportunity or find a way to mitigate the risk.

In order to mitigate the risk, Kapoor says that depending on the credit worthiness of the buyer, various forms of payment and credit enhancements can be considered – for example through purchase of credit insurance or asking the buyer to make payment under a letter of credit (LC) or even through the provision of a stand by LC. As a result the company is able to mitigate tenor extension risk and make the structure more bankable thereby allowing it to seek financing and actively manage its cash flows. There are, he further notes, a number of examples of industrial corporates successfully adopting this approach including for medium to large value sales.

For smaller-value trades such as in FMCG, although currently experiencing less of a sales slow-down, Kapoor says growth can be sustained and even increased through portfolio financing solutions. Here, for example, a large corporate supplier can partner with a bank to sell receivables due from a large number of buyers on a programmed basis. Such solutions typically benefit from either a credit wrap, provided by a large insurer that covers commercial and political risks related to the buyers, or some sort of credit risk sharing arrangement between the corporate and the bank.

However it is achieved, the onus to seek out models of growth enablement is clearly about partnership, says Kapoor. The needs of all internal parties must be identified but it is also important for the bank to engage with its client on the business side, not just on the finance side, “to better understand how best to facilitate that growth”.

Partnering for success

It is apparent that the slowing down of growth has seen the increased collaboration of two sides that historically have not always been quite so communicative. With the banking community having also stepped up its involvement in both corporate finance and business matters, it has been necessary for banks to ensure all points of contact have the right skills and understanding to meet the advanced (and advancing) needs of clients. “The tools are the same, but it is how we use those tools in the context of growth to solve some of the challenges that our clients face that makes the difference,” notes Kapoor. Banks need to “better understand the needs of corporates in this changing environment” for this partnership to yield positive results.

The current climate is such that the intelligent adaptation by a bank of its product portfolio is well-received by corporate clients. But for banks to deliver real value, Kapoor believes lateral thinking about its own products and processes, and its clients’ strategies, tactics and policies, should benefit the recipient as part of a sustained, and sustainable, programme of support. “Through good times and bad we continue to assist clients in supporting their business growth and helping to set some new best practices,” he comments.

But Kapoor points out that this usually requires a customised approach. As each client’s circumstances are unique he says it is “more solution-oriented than product-oriented and we need to find the best fit for the client’s need”.

Ultimately, all stakeholders – both internal and external – are called upon to react to the demands of a dynamic growth environment, eking out advantage wherever possible. It thus behoves the quick-witted treasurer to collaborate with those other stakeholders to establish what Kapoor calls an “evergreen” response – one that will outlast any short-term buffeting by the markets, providing security long into the future. The root of success in this instance may be a declining market but, as he asserts, “adversity creates opportunity”.

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