Corporate Debt Hotspots May Be Bubbling Under a Calm Surface
Wednesday, August 15, 2018
A positive global trend to strengthen corporate balance sheets and reduce gearing is masking a rise in leverage in vulnerable sectors and regions and this in turn is creating hotspots of increased risk for cross border trade, according to the latest research on global corporate debt from trade credit insurer Euler Hermes.
Despite a general rise in global debt, the average net gearing ratio for businesses fell to 53 percent in 2017, down 3.2 percent year-on-year. The trade credit insurer says the positive picture has been supported by strengthening balance sheet structures, which in turn are supported by sustained earnings growth.
Risk is concentrated in sectors that face structural change, notably disruption from climate change, digitalization, changing customer needs or challenging economic performance, according to Euler Hermes. The sectors most at risk include paper, transportation and textile, and businesses are increasing leverage to see themselves through challenging conditions and respond to these changes.
From a regional perspective, the research found that Southern Europe was particularly vulnerable to over-leveraged corporates. Portugal (96 percent), Turkey (72 percent), Spain (68 percent) and Greece (69 percent) all recorded the highest net gearing ratios. This is compared to the lowest average levels found in South Africa (38 percent), Australia (41 percent), Hong Kong (42 percent), Poland (43 percent) and the UK (43 percent).
High risk sectors
The paper industry is a highly capital-intensive industry and requires considerable leverage. As it tackles structural challenges of digitalization, the issue is compounded and has led to the sector recording the highest average net gearing ratio, at 172 percent for the top 25 percent (top quartile) comprising the highest leveraged constituents. According to the research, net gearing reduced by 7.6pp for 2017 against 2016 levels.
While leverage is high and energy input price pressures remain, margins should still improve by 20 bps in 2018 as demographics and consumption patterns boost growth in tissue and packaging production.
The transport industry is exposed to considerable structural change and has little financial cushioning to weather the risk. With 144 percent average net gearing for the top 25 percent of companies, leverage is high, while cashflow is weak. The industry is facing the challenges of rising oil prices, a need to invest in new technology and fleets to drive fuel economy and meet climate change regulations.
Textile is a high-risk sector with a combination of significant leverage, 144 percent in the highest quartile of indebted companies and weak cash generation. Intense competition is the mainstay of structural headwinds, notably for industries in US, Japan, Singapore and India.