Whatever role low interest rates and high government spending may have played in helping economies stabilise during the global slowdown, they now have companies, investors, and policymakers on the lookout for inflation to come roaring back.
Economists are already warning of a return to the experience of the 1970s, when inflation in the developed countries of Europe and North America hovered at about 10 per cent. That level is not uncommon in Latin America and Asia, where emerging economies have seen double-digit inflation for many years.
At first glance, the effects of inflation on a company's ability to create value may seem negligible. After all, as long as managers can pass increased costs on to the customer, they can keep inflation from eroding shareholder value. Most managers believe that to achieve this goal, they need only ensure that earnings grow at the rate of inflation.
But a closer examination reveals that to fend off inflation's value-destroying effects, earnings must grow much faster. That is a target companies typically do not hit, as history shows. In the mid-1970s to the 1980s, for instance, US companies managed to increase their earnings per share at a rate roughly equal to that of inflation - about 10 per cent.
But to preserve shareholder value, our analysis finds, they would actually have had to increase their earnings growth by about 20 per cent. This shortfall was one of the main reasons for poor stock market returns in those years.
Inflation makes it harder to create value for several reasons, especially when its annual growth rate exceeds long-term levels of between 2 and 3 per cent, and becomes unpredictable for managers and investors.
When that happens, it can push up the cost of capital in real terms and lead to losses on net asset positions that are fixed in nominal terms.
But inflation's biggest threat to shareholder value lies in the inability of most companies to pass on cost increases to their customers in full without losing sales. When they fail to pass on all of their rising costs, they are unable to maintain their cash flows in real terms.
To illustrate the point, let us examine the case of a hypothetical company that generates steady sales of $1,000 (Dh3,672) a year, with earnings before interest, taxes and amortisation (Ebita) of $100 and invested capital of $1,000. If the cost of capital is 8 per cent, the company's discounted cash flow value at the start of year two equals $1,250.2.
Now assume that inflation suddenly increases from zero to 15 per cent in year two and stays at that level, and that costs and capital expenditures are affected equally.
Also assume that the company can increase its earnings at the rate of inflation and maintain its 10 per cent sales margin by increasing prices for its products while keeping sales volumes and physical production capacity constant.
In the process, it will lift its returns on capital to almost 20 per cent after 15 years.
This level of performance may seem impressive or at least adequate. Yet not all is as it seems. The growth of free cash flows would be negative in the first five years and only gradually rise to the rate of inflation after 17 years.
That, combined with an increase in the cost of capital, to 24 per cent, pushes down the company's value to as little as $481.50. To fully pass on inflation to customers without any loss of sales, the company would need to raise its cash flows at the rate of inflation, not its earnings, as many practitioners surmise.
But if all cash flows grow with inflation, the implication is that the company's reported financial performance increases sharply.
In year two, earnings growth would have to exceed 33 per cent; sales margins would have to increase to 11.6 per cent, from 10 per cent; and returns on invested capital (ROIC) to 13.4 per cent, from 10 per cent.
After 15 years of constant inflation, margins and ROIC would end up at 17.6 per cent and 34.7 per cent, respectively. The company's ROIC must rise that far to keep up with inflation and the higher cost of capital.
The reason is that invested capital and depreciation, instead of tracking inflation precisely, are usually delayed. In year two, for example, annual capital expenditures increase by 15 per cent, but this adds only negligibly to invested capital. Annual depreciation also changes in year 36 by only a small amount.
And because in each year only one 15th of the company's assets are replaced at inflated prices, it takes 15 years of constantly rising prices to reach a steady state where capital and depreciation grow at the rate of inflation. All the while, sales margins and ROIC increase each year until the company reaches the steady state in year 17.
Although this example is stylised, the conclusion applies to all companies: after each acceleration in inflation, reported earnings should be expected to outpace inflation, and reported sales margins and returns on capital to increase, even though in real terms nothing has changed.
Unfortunately, history shows that in periods of rising inflation, companies do not achieve big improvements in reported returns on capital. Those returns have been remarkably stable, at around 8 to 11 per cent, in the US, even during the 1970s and early 1980s, when inflation hit 10 per cent or more.
If companies had been successful in passing on inflation's effects, they would have had returns of about 25 to 30 per cent in those years. Instead, they barely managed to keep returns at pre-inflation levels.
One reason companies are likely to destroy value is that they are unable pass on cost increases to customers or can do so only with a time lag. This problem is especially costly when inflation is high and unpredictable: a half-year delay in passing on 15 per cent inflation implies that revenues are always 7.5 per cent too low, causing margins to drop rapidly.
Another reason could be that managers facing inflation fail to sufficiently adjust their targets for the growth of earnings and sales margins. Keeping margins and returns on capital constant in times of inflation means that cash flows and value are eroding in real terms.
Growth of Ebita in line with inflation is also insufficient for sustaining a company's value. This is even more true for leveraged indicators, such as earnings per share.
Whatever the exact reason may be, history shows that companies do not manage to pass on inflation fully, so their cash flows decline in real terms.
There is also empirical evidence that in times of inflation, investors increase the cost of capital in real terms. Lower cash flows and a higher cost of capital are a proven recipe for lower share prices, just as we saw in the 1970s and 1980s.
Marc Goedhart is a consultant in the Amsterdam office of McKinsey and Co, the management consultant, Tim Koller is a partner in the New York office and David Wessels, formerly of the New York office, is an adjunct professor of finance at the University of Pennsylvania's Wharton School.
Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.
Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.
“Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.
Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.
“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.
Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.
From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.
Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.
BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.
Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.
Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.
“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.
Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.
“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.
“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”
The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”
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The specs: 2017 Ford F-150 Raptor
Price, base / as tested Dh220,000 / Dh320,000
Engine 3.5L V6
Transmission 10-speed automatic
Power 421hp @ 6,000rpm
Torque 678Nm @ 3,750rpm
Fuel economy, combined 14.1L / 100km
Haircare resolutions 2021
From Beirut and Amman to London and now Dubai, hairstylist George Massoud has seen the same mistakes made by customers all over the world. In the chair or at-home hair care, here are the resolutions he wishes his customers would make for the year ahead.
1. 'I will seek consultation from professionals'
You may know what you want, but are you sure it’s going to suit you? Haircare professionals can tell you what will work best with your skin tone, hair texture and lifestyle.
2. 'I will tell my hairdresser when I’m not happy'
Massoud says it’s better to offer constructive criticism to work on in the future. Your hairdresser will learn, and you may discover how to communicate exactly what you want more effectively the next time.
3. ‘I will treat my hair better out of the chair’
Damage control is a big part of most hairstylists’ work right now, but it can be avoided. Steer clear of over-colouring at home, try and pursue one hair brand at a time and never, ever use a straightener on still drying hair, pleads Massoud.
Specs
Engine: 51.5kW electric motor
Range: 400km
Power: 134bhp
Torque: 175Nm
Price: From Dh98,800
Available: Now
Specs
Engine: Electric motor generating 54.2kWh (Cooper SE and Aceman SE), 64.6kW (Countryman All4 SE)
Power: 218hp (Cooper and Aceman), 313hp (Countryman)
Torque: 330Nm (Cooper and Aceman), 494Nm (Countryman)
On sale: Now
Price: From Dh158,000 (Cooper), Dh168,000 (Aceman), Dh190,000 (Countryman)
The rules on fostering in the UAE
A foster couple or family must:
- be Muslim, Emirati and be residing in the UAE
- not be younger than 25 years old
- not have been convicted of offences or crimes involving moral turpitude
- be free of infectious diseases or psychological and mental disorders
- have the ability to support its members and the foster child financially
- undertake to treat and raise the child in a proper manner and take care of his or her health and well-being
- A single, divorced or widowed Muslim Emirati female, residing in the UAE may apply to foster a child if she is at least 30 years old and able to support the child financially
NO OTHER LAND
Director: Basel Adra, Yuval Abraham, Rachel Szor, Hamdan Ballal
Stars: Basel Adra, Yuval Abraham
Rating: 3.5/5
The most expensive investment mistake you will ever make
When is the best time to start saving in a pension? The answer is simple – at the earliest possible moment. The first pound, euro, dollar or dirham you invest is the most valuable, as it has so much longer to grow in value. If you start in your twenties, it could be invested for 40 years or more, which means you have decades for compound interest to work its magic.
“You get growth upon growth upon growth, followed by more growth. The earlier you start the process, the more it will all roll up,” says Chris Davies, chartered financial planner at The Fry Group in Dubai.
This table shows how much you would have in your pension at age 65, depending on when you start and how much you pay in (it assumes your investments grow 7 per cent a year after charges and you have no other savings).
|
Age
|
$250 a month
|
$500 a month
|
$1,000 a month
|
|
25
|
$640,829
|
$1,281,657
|
$2,563,315
|
|
35
|
$303,219
|
$606,439
|
$1,212,877
|
|
45
|
$131,596
|
$263,191
|
$526,382
|
|
55
|
$44,351
|
$88,702
|
$177,403
|
West Indies v India - Third ODI
India 251-4 (50 overs)
Dhoni (78*), Rahane (72), Jadhav (40)
Cummins (2-56), Bishoo (1-38)
West Indies 158 (38.1 overs)
Mohammed (40), Powell (30), Hope (24)
Ashwin (3-28), Yadav (3-41), Pandya (2-32)
India won by 93 runs
In numbers: PKK’s money network in Europe
Germany: PKK collectors typically bring in $18 million in cash a year – amount has trebled since 2010
Revolutionary tax: Investigators say about $2 million a year raised from ‘tax collection’ around Marseille
Extortion: Gunman convicted in 2023 of demanding $10,000 from Kurdish businessman in Stockholm
Drug trade: PKK income claimed by Turkish anti-drugs force in 2024 to be as high as $500 million a year
Denmark: PKK one of two terrorist groups along with Iranian separatists ASMLA to raise “two-digit million amounts”
Contributions: Hundreds of euros expected from typical Kurdish families and thousands from business owners
TV channel: Kurdish Roj TV accounts frozen and went bankrupt after Denmark fined it more than $1 million over PKK links in 2013
The End of Loneliness
Benedict Wells
Translated from the German by Charlotte Collins
Sceptre
Ms Yang's top tips for parents new to the UAE
- Join parent networks
- Look beyond school fees
- Keep an open mind
Cry Macho
Director: Clint Eastwood
Stars: Clint Eastwood, Dwight Yoakam
Rating:**
Schedule for Asia Cup
Sept 15: Bangladesh v Sri Lanka (Dubai)
Sept 16: Pakistan v Qualifier (Dubai)
Sept 17: Sri Lanka v Afghanistan (Abu Dhabi)
Sept 18: India v Qualifier (Dubai)
Sept 19: India v Pakistan (Dubai)
Sept 20: Bangladesh v Afghanistan (Abu Dhabi) Super Four
Sept 21: Group A Winner v Group B Runner-up (Dubai)
Sept 21: Group B Winner v Group A Runner-up (Abu Dhabi)
Sept 23: Group A Winner v Group A Runner-up (Dubai)
Sept 23: Group B Winner v Group B Runner-up (Abu Dhabi)
Sept 25: Group A Winner v Group B Winner (Dubai)
Sept 26: Group A Runner-up v Group B Runner-up (Abu Dhabi)
Sept 28: Final (Dubai)
The bio
Who inspires you?
I am in awe of the remarkable women in the Arab region, both big and small, pushing boundaries and becoming role models for generations. Emily Nasrallah was a writer, journalist, teacher and women’s rights activist
How do you relax?
Yoga relaxes me and helps me relieve tension, especially now when we’re practically chained to laptops and desks. I enjoy learning more about music and the history of famous music bands and genres.
What is favourite book?
The Perks of Being a Wallflower - I think I've read it more than 7 times
What is your favourite Arabic film?
Hala2 Lawen (Translation: Where Do We Go Now?) by Nadine Labaki
What is favourite English film?
Mamma Mia
Best piece of advice to someone looking for a career at Google?
If you’re interested in a career at Google, deep dive into the different career paths and pinpoint the space you want to join. When you know your space, you’re likely to identify the skills you need to develop.
Ain Issa camp:
- Established in 2016
- Houses 13,309 people, 2,092 families, 62 per cent children
- Of the adult population, 49 per cent men, 51 per cent women (not including foreigners annexe)
- Most from Deir Ezzor and Raqqa
- 950 foreigners linked to ISIS and their families
- NGO Blumont runs camp management for the UN
- One of the nine official (UN recognised) camps in the region
More from Neighbourhood Watch:
Key facilities
- Olympic-size swimming pool with a split bulkhead for multi-use configurations, including water polo and 50m/25m training lanes
- Premier League-standard football pitch
- 400m Olympic running track
- NBA-spec basketball court with auditorium
- 600-seat auditorium
- Spaces for historical and cultural exploration
- An elevated football field that doubles as a helipad
- Specialist robotics and science laboratories
- AR and VR-enabled learning centres
- Disruption Lab and Research Centre for developing entrepreneurial skills
Company%20profile
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Expo details
Expo 2020 Dubai will be the first World Expo to be held in the Middle East, Africa and South Asia
The world fair will run for six months from October 20, 2020 to April 10, 2021.
It is expected to attract 25 million visits
Some 70 per cent visitors are projected to come from outside the UAE, the largest proportion of international visitors in the 167-year history of World Expos.
More than 30,000 volunteers are required for Expo 2020
The site covers a total of 4.38 sqkm, including a 2 sqkm gated area
It is located adjacent to Al Maktoum International Airport in Dubai South
THREE
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A MINECRAFT MOVIE
Director: Jared Hess
Starring: Jack Black, Jennifer Coolidge, Jason Momoa
Rating: 3/5
Company profile
Name: Infinite8
Based: Dubai
Launch year: 2017
Number of employees: 90
Sector: Online gaming industry
Funding: $1.2m from a UAE angel investor
KEY HIGHLIGHTS
Healthcare spending to double to $2.2 trillion rupees
Launched a 641billion-rupee federal health scheme
Allotted 200 billion rupees for the recapitalisation of state-run banks
Around 1.75 trillion rupees allotted for privatisation and stake sales in state-owned assets
The specs: 2018 Audi Q5/SQ5
Price, base: Dh183,900 / Dh249,000
Engine: 2.0L, turbocharged in-line four-cylinder / 3.0L, turbocharged V6
Gearbox: Seven-speed automatic / Eight-speed automatic
Power: 252hp @ 5,000rpm / 354hp @ 5,400rpm
Torque: 370Nm @ 1,600rpm / 500Nm @ 1,370rpm
Fuel economy: combined 7.2L / 100km / 8.3L / 100km
