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Canadian businesses should leverage their cash hoard to take advantage of optimal business conditions, according to Benjamin Tal, deputy chief economist at CIBC World Markets Inc.
Stable profit margins, robust growth prospects and a strong loonie offer businesses an opportune moment to started flexing their financial muscle and deploy their cash pile that now stands at around $150 billion, according to an Oct. 7 report by Tal and senior economist Katherine Judge.
Some industries such as high tech and manufacturing are uniquely positioned for investment.
“This cash level is something that we haven’t seen in a generation,” said Tal. “And the point that I’m making is that if they don’t invest now when are they going to invest?”
Canadian cash positions are even more favourable when compared to the U.S., as U.S. government income support was more targeted to households and less towards businesses. As a result, corporate Canada holds nearly double the amount of cash its U.S. counterparts do as a share of assets.
As to what factors may entice companies to unleash cash holdings, Tal said the continued opening of the economy may encourage investment.
Tal said that the value of the Canadian dollar is another factor that might incentivize business investment, due in part to potential cost savings on imports such as equipment and machinery.
“So as long as the Canadian dollar is relatively elevated, and I think it will remain, even anything between 75 and 80 U.S. cents would actually be a good opportunity for them to take advantage of that value,” said Tal. “So, I think that this opportunity will be there for a few years.”
However, the strong loonie likely won’t last.
The loonie strengthened against the U.S. dollar during the COVID-19 recovery only to slip earlier this year. The Canadian dollar has rebounded to above 80 U.S. cents for this first time since July on the back of higher commodity prices, but monetary tightening by the U.S. Federal Reserve could cool the loonie rally against the greenback.
Canadian businesses have also been experiencing healthy profits, which also contributes to the current opportunity for investment. This is due in part to reductions in consumer price sensitivity during the pandemic, allowing businesses to pass through higher production costs while avoiding effects on demand.
However, Tal said he expects consumers to become price sensitive again in the future.
Healthy profit margins experienced by Canadian businesses may contribute to the currently favourable investment position, but lack of business investment has been the trend for over a decade. Following the 2008 financial crisis, there was a structural decline in corporate Canada’s investment appetite that has not rebounded.
Business investment in Canada lagged during COVID-19, compared to the U.S., which has already fully recovered in relation to business investment.
But lacklustre investment is not just a COVID-induced malaise: non-energy business investment fell by 8.1 per cent in 2020 in Canada, and management consultancy Deloitte expects an increase in business investment of a paltry 1.9 per cent in 2021, based on a weak recovery in the first half of the year.
“This is a significantly worse performance than experienced in the United States, where investment as a share of GDP is far higher. Numerous factors are weighing on Canadian investment, including the availability of labour, electricity costs, comparative taxes, and relative competitiveness,” Deloitte noted in its economic outlook in October.
Additionally, rising public sector investment has mitigated Canada’s lack of investment. Currently, public sector investment makes up at least 40 per cent of total investment, doing much of the heavy lifting, but the private sector will have to step up soon.
“Consumers and governments are highly leveraged and that will impact their ability to constantly increase their spending,” Craig Alexander, chief economist at Deloitte Canada said in a report. “While businesses are expected to increase their spending over the near term and exports will increase, investment in Canada has been chronically weak and this is limiting our ability to increase our exports.”
Underinvestment is especially evident in the equipment and machinery industry, which sits at six per cent below its pre-pandemic level.
Explanations for lack of investment activity run the gamut and include Canada’s relatively large contingent of small and mid-sized companies, which tend to invest less frequently than larger firms.
Other explanations include a lower cost of labour in Canada and a high degree of foreign investment. This means fewer investments in Canada as multinationals generally purchase assets in their home nation and deploy them in Canada.
“Capacity utilization levels are already in line with pre-pandemic norms in the industrial sector, and are nearing the last cycle’s peak. The urgency of investment is raised by supply chain bottlenecks that will increase the lead time of receiving equipment,” wrote CIBC’s Tal in his note.
“Another factor to consider is the cost of labour. These are early days, but given the current shortage of labour it’s possible that the ongoing and future pressure on wages might work to increase the motivation to substitute capital for labour.”
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