Do your forecasts still stack up?

This week’s blog comes from Natalia Pugach, a Director in our Restructuring Modelling team.

High profile failures, profit warnings and asset write-downs have put the spotlight on how well companies are measuring their performance and delivering against their forecasts and investment hypotheses.

Deals, debt arrangements and forecasts made in brighter times are coming under greater scrutiny. Trust is in shorter supply and companies need to be more mindful of how well they are tracking their performance and meeting stakeholders’ expectations everyday – but particularly as they approach pivotal capital events.

In this blog, I’ll look at why tracking and delivering against expectations has become more problematic and how and where companies can use analytics to create better outcomes.

A more difficult market to read…

In Q1 2018, almost half of UK companies issuing profit warnings had already warned in the last year. For a quarter of companies warning in Q1 2018, this was at least their third profit alert in the last 12 months.

This increasing incidence of multiple profit warnings suggests that more companies are facing an increasing struggle: to tap into more limited growth; to adapt to rapid changes in their markets; and – more fundamentally – to get accurate grip on their numbers. Profit warnings are essentially companies alerting the stock market that they won’t meet market expectations – and for some companies to setting expectations is getting harder.

Sometimes this is due to unavoidable shocks. But too often it’s due to companies failing to forecast accurately because they don’t have an accurate picture of how their whole business is performing. This could be due to a number of interconnected reasons, which could include failure to track useful or relevant data or an inability to make the most of and properly interpret the data that is available.

In today’s fast moving economic, political and digital climate it has undoubtedly become more difficult to make predictions and to know what and how to track. But this is a vital  battle to win. Profit warnings in Q1 2018 triggered an average 19.3% fall in share price on the day of warning – the highest since mid-2016 – with a much higher price paid by companies who have lost the trust of lenders and other stakeholders.

The forecasting battle

Potential for shocks 2018 has thrown up a series of geo-political, policy and price uncertainties, from increasing geopolitical risks in the Middle East and Europe, to the trade wars, ongoing Brexit uncertainties, a rise in emerging market stresses and oil moving to $80 a barrel.
Currency volatility Diverging polices and uncertainty around the pace of monetary tightening continues to drive currency volatility in 2018. Exchange rate changes triggered the highest number of UK profit warnings since mid-2014 in Q1 2018
Competitive stress Low levels of insolvency in this recovery have left many sectors with significant overcapacity, generating intense competition. ‘Disruptive’ new entrants and a technological revolution have added to the competitive tension.
New models Historical trends and relationships are a poor guide to the future. New economic, business and behavioural models are required to predict demand. Technological changes are rapidly altering the way we live, work and shop.

…which could have broader implications

What this all illustrates is the need for all managers and stakeholders to keep closer eye on forecasts and performance – and not just within listed companies. This is a very different world to which many PE deals came to market and in which many companies made M&A growth and synergy assumptions. Companies must of course keep adapting their model – which we’re increasingly seeing through additional investment and M&A. But it’s vital too that they continue to optimise performance and don’t lose sight of the everyday numbers and how they are stacking up.

This is especially important in the lead up to pivotal capital events such as IPOs, refinancing and asset sales, where last minute concerns over the robustness of the forecasts, and therefore performance, could scupper a deal.

Looking ahead, hitting the numbers being forecast right now in M&A and PE investment hypotheses  could become increasingly challenging, with all the difficulties discussed so far compounded by the rising multiples being paid in today’s competitive markets.  Competition for quality assets is fierce and PE valuations have reached new heights, with the average EV/EBITDA multiple closing in on 11x last year, the highest since the financial crisis, according to Pitchbook.

Meanwhile, the refinancing hump also keeps moving away. The speculative grade peak is now 2024, according to S&P. But at some point a substantial amount of debt will need to be refinanced on less attractive terms. In Europe first-lien debt to EBITDA ratios have now reached pre-crisis levels.

Do you already have the answer?

The problem we’ve found with many companies is that the sheer amount and complexity of data available means that they’re not always looking in the right places or getting the most out of their data. Essentially they have too much information and limited insight. Business leaders may be focusing on operational and commercial KPIs, without focusing enough on the financial ones. What might look like insights may also be unreliable or slow due to errors in manual processes.

Data that is misunderstood, misanalysed or overlooked represents unmeasured risk and a missed opportunity. In the face of growing competition and complexity, business success requires a new approach based on fact based decision-making – one that allows organisations to continuously track performance reliably and in a transparent way and one which allows companies to identify opportunities quickly, wherever they are in their deal cycle. This is why companies are increasing using financial and non-financial modelling and data analytics to improve the effectiveness of financial, operational and commercial KPIs.

Questions to ask…

Can your data tell you…?

  • The real cost to serve? Where are the opportunities to reduce costs?
  • Where you can improve productivity?  What are your real people costs – including your contingent workforce?

  • How you can release and manage cash and working capital? Do you have cash-flow visibility across your business?
  • Where you can optimise your supply chain? Do you understand your supply chain cost drivers? Are your stock levels are the right level?
  • How your stores/business units perform under different operating conditions? Why does performance vary? How can you optimise returns?
  • If your resources are sufficient to deliver our strategic growth plans? Does our business have the skills and capacity to deliver on your business strategy?

Improving data visibility across the business can have significant benefits, from increasing the speed and quality of decision making, increasing investor confidence, improving governance and focus attention and effort on what really matters – all of which goes straight to the bottom line.

Natalia Pugach