Global trade credit insurance giant, Euler Hermes, has warned that 2016 is set to be a tough year for corporates as companies face a series of short- and long-term challenges.
According to their latest report, which analyzes 18 financial sectors in 72 countries, and spans 1 300 industries, one in four industries find themselves in sensitive of high-risk territory in at the beginning of 2016.
“Management teams will need to keep a cool head in the coming months, after the adrenaline rush caused by volatile financial markets,” says Ludovic Subran, chief economist at Euler Hermes. “In 2015, 148 industries were downgraded in our analysis, and only 76 were upgraded.
“In some sectors, such as energy, machinery and equipment and metals, companies are caught between short-term challenges including low commodity prices, erratic emerging market demand and debt overhang, as well as rapid disruption and unwanted consolidation over the medium term.”
The report, titled ‘Let the Sector Games Begin – Companies are having an early start at their own Olympics’, identifies five macro challenges for corporates in 2016:
- Protracted period of low commodity prices
The machinery and equipment sectors will be hard hit by subdued oil prices, which will prompt an estimated 25% drop in oil-related investment activity.
Other commodities, such as iron ore, are expected to see further price drops during the course of the year, which will continue to heavily impact the already embattled metal sector, with 61 out of 72 countries monitored having a sensitive or high risk rating by Euler Hermes underwriters.
The big winner, due mostly to low global oil prices, is the transportation sector, having seen eight upgrades in 2015, especially in European countries.
- Turmoil in emerging markets
Emerging markets witnessed an unprecedented number of sector risk downgrades in 2015 – 122 to be exact – with very few upgrades.
Africa and the Middle East experienced a total of 39 sector downgrades while Latin America saw 34 sectors downgraded.
Brazil has borne the biggest brunt of the Global economic downturn, with 15 out of 18 monitored industries facing sensitive or high-risk ratings by Euler Hermes.
Western Europe helped balance the the global risk profile with 24 sector upgrades.
- Increasing debt, payment terms and credit risk
Day sales outstanding (DSO), a key indicator of cash flow as well as insolvencies, have been increasing globally for some time now.
In China, DSO rose to 81 days in 2015 and is expected to reach 84 days in 2016, with insolvencies expected to rise by 20%.
Alarm bells are sounding for debt levels – even adjusted for cash – with net gearing ratios as high as 108% for metals and up to 92% for machinery and equipment as well as paper.
- More disruption
The rise of e-commerce and mobile technology, already representing USD 3,5tn, is but one example of how disruption entails further risk for traditional industries in an already subdued investment cycle fuelled by global volatility and economic uncertainty.
The three main identified determinants for the growing risk of disruption when comparing industries globally are distance to customer, divestment from research and development (R&D), and dependence on infrastructure.
- Another M&A wave
Corporates are increasingly exploring acquisition opportunities as opportunities for organic growth diminish. Global mergers and acquisitions are again expected to exceed USD 4tn in 2016, with deal volumes expected to increase by 10% to 20 000 transactions.
These figures are driven by strong activity in the chemicals, pharmaceuticals and technologies sectors, with cross-border transactions driven by a 17% increase of Asian companies targeting European firms in 2015.
South Africa: short-term factors add to structural growth
The South African business environment has been dogged by ongoing structural rigidities for some time now. These include uneasy labour relations and periodic disruptions in electricity supply.
Other factors affecting business in the country include weak international commodity prices, with commodities accounting for 14% of total DGP.
The economic slowdown in China – the country’s largest trade partner, the extensive drought conditions resulting in weakened agricultural output as well as a need to import maize and other foodstuffs, and uncertainty relating to the tightening of US monetary policy has also contributed to compounding the country’s business woes.
The country’s GDP grew by an average of 5,4% in the period 2004 to 2007, but the ten-year average ending in 2015, showed growth of only 2,6%.
According to the report, expansion rates of approximately 5% are required to make meaningful improvements in incomes and living standards, however, GDP growth was severely limited by structural impediments, which include a lack of skilled labour, limited job creation, high unemployment and underemployment, infrastructure bottlenecks, weak public sector delivery and erratic electricity supply.
Despite official estimates showing expected GDP growth of between 1,9 and 2,3%, Euler Hermes expects annual GDP growth of 1% in 2016 and 1,5% in 2017.
“Against this background, insolvencies will increase by 10% year-on-year in 2016,” says Euler Hermes South Africa Country manager, Greg Nosworthy. “This will be the first outright deterioration since 2009 and the global financial crisis.
“The construction sector is already registering an increase in insolvencies. Moreover, a generalised significant lengthening in DSO is already apparent.”