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Analysis: Strained finances trip up French firms' recovery role

France's President Francois Hollande addresses a news conference at an European Union leaders summit in Brussels October 25, 2013. REUTERS/L
France's President Francois Hollande addresses a news conference at an European Union leaders summit in Brussels October 25, 2013. REUTERS/L

By Leigh Thomas

PARIS (Reuters) - Squeezed by thin margins and high debt, French companies will struggle to ramp up the investment spending on which President Francois Hollande's government is banking to underpin a fragile recovery.

Hollande's government has hung its 2014 recovery hopes on business investment taking over consumer spending's traditional role as the motor of growth in the euro zone's second largest economy.

It expects growth to reach at least 0.9 percent in 2014, counting on a corporate tax credit scheme to boost overall business investment by 1.5 percent and even more for spending on new equipment even though spare capacity is ample at nearly six percentage points below the long-term average.

"It's all just political mumbo-jumbo," said Pierre Vauterin, chief executive of CBA, which makes airplane parts outside Paris and employs about 65 people.

"I don't see any grounds to prophesy an investment rebound," added Vauterin, who said his company's 2014 budget would focus what little investment was possible on improving quality and performance rather than boosting production.

Under the tax credit scheme designed to cut labor costs by 10 billion euros ($13.8 billion) next year, the government sees average French operating margins rising to 28.7 percent from an estimated 28.2 percent this year. By 2015, it hopes to have cut labor costs by 20 billion euros or six percentage points.

But France has the weakest margins in Europe, and analysts say such improvements will do little in the short term to restore French profitability to levels enjoyed elsewhere in the euro zone, where the average operating margin is nearly 38 percent.

"There's a real problem with profit margins and this problem is going to hold back any recovery because there will be fewer means to invest," Bank of France head of structural analysis Gilbert Cette said.

Forecasting 0.7 percent growth on average for next year, economists polled by Reuters are not too far short of the government's own 0.9 percent target.

But if any risks emerge to threaten that scenario, the corporate sector will struggle to pick up the slack. According to estimates compiled by Thomson Reuters, analysts see roughly flat capital spending by the 40 largest companies listed on France's CAC-40 index.

SURVIVING, NOT THRIVING

The weak profitability of French firms has meant they have taken on debt to try and maintain investment levels as much as possible, leading corporate debt to pile up to near record levels at close to 66 percent of economic output - a fact that further restricts room for maneuver.

Though Spanish and Italian firms shoulder much bigger debt burdens, they have better margins, and Spanish firms for their part are deleveraging quickly. Spanish firms have cut debt from about 118 percent of GDP in 2010 to less than 100 percent now.

Though business sentiment surveys suggest optimism is rising among French firms, many executives remain stuck in a retrenchment mindset rather than in the mood for expansion.

Chief financial officers' top priority remains cutting costs followed by expanding margins through internal growth, according to a survey of 74 CFOs by Deloitte.

"Companies are going to try to scrape by next year by closely managing cash flow and investments," Vauterin said, adding that he was careful to keep cash flow positive in order to steer clear of needing credit.

The phenomenon is visible from small and medium-sized firms like CBA, the aircraft parts manufacturer, right through to France's top groups.

Eager to win back an investment grade credit rating, the top priority of building materials group Lafarge is to cut net debt to less than 10 billion euros this year and get it down to less than 9 billion next year.

In its last analyst conference call in July, management repeatedly stressed capital spending was subject to "strict discipline" and the little investment in the works would target fast-growing emerging economies rather than France.

Also constrained by non-investment grade credit rating, power and infrastructure group Alstom lacks the financial muscle to buy businesses that would help it compete with bigger rivals like GE and Siemens, analysts told Reuters.

With the company balance sheet limiting investment options, CEO Patrick Kron says the focus is squarely on cost cutting.

"This doesn't mean that we'll stop R&D (research and development) or that we'll stop investing ... but we'll tighten the bolts wherever it's possible," he said last month.

RATE RISK

Boosting growth to jump-start job creation is the top political priority of Hollande's government, with unemployment around 11 percent. But some companies acknowledge that any investment they make will not help that goal.

"What we're seeing is investment to get productivity gains rather than increasing capacity," said Pierre Marol, CEO of airport equipment firm Alstef.

Marol said new retirement rules requiring special compensation for jobs deemed particularly strenuous would encourage firms to invest in robotic machines, not workers.

Though historically low interest rates have allowed French companies to keep investment from collapsing, firms are particularly vulnerable to a rise in the cost of borrowing.

"A rates increase would seriously weaken French companies' financial situation and make financing investment much more difficult," the Bank of France's Cette said.

Wary of future rate rises, companies are rushing to lock in low rates on debt markets, where they can currently borrow even more cheaply than from banks, according to Bank of France data.

The government hopes smaller firms cut off from financial markets can secure funds at a new public investment bank.

But Pierre Gattaz, the head of the Medef employers association, is not so much worried about a lack of credit as he is about a global recovery leaving French firms behind as they struggle with one of the highest tax burdens in Europe.

"We will not benefit from better global growth if we don't take measures to boost the French economy's competitiveness," he said. "The world is moving and France has got to move too." ($1 = 0.7260 euros)

(Reporting by Leigh Thomas; Additional reporting by Benjamin Mallet; editing by Mark John and Giles Elgood)

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