Falling interest rates, while helpful, are not yet enough to significantly improve companies’ financial situation, but outlook is expected to improve this year

02/16/2024

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Ricardo Jacomassi — Foto: Gabriel Reis/Valor

Even with the onset of the monetary easing cycle, the country has yet to witness a significant improvement in the situation of companies, which are struggling with declining sales and gross profit margins. A study by the Center of Capital Market Studies (Cemec-Fipe) reveals that the number of publicly traded companies unable to cover their financial expenses with their cash generation is high, and the indicators are likely to deteriorate in the coming months.

That is the result of a period of still high-interest rates. However, the survey indicates that spending on financial charges shows a “clear downward trend,” while the drop in profits is less severe. According to Carlos Antonio Rocca, coordinator of Cemec-Fipe, the scenario should begin to improve this year.

The current picture presented by the study is challenging: the default rate for businesses remained high, at 3.58% in November last year, more than double the rate at the end of 2020 (1.45%). Consultancies specializing in debt restructuring report that demand from companies seeking renegotiation with creditors, a buyer or partner, or court-supervised reorganization has increased significantly. Experts named construction, retail, and agribusiness among the most problematic sectors.

“The number of inquiries we’ve been receiving from companies with debts of more than R$200 million has risen considerably,” stated Ricardo Knoepfelmacher, founder of RK Partners, a firm specializing in restructuring. A survey by the consultancy indicates that, on average, working capital credit rates have decreased by three percentage points from January 2023 to last month, from 30.3% to 27.3% per year, indicating still quite high levels. Concurrently, the capital market remains very selective following the cases of Americanas and Light at the beginning of last year.

In accordance with the scenario indicated by Cemec, the RK study shows that among publicly traded companies, 27% have generated less profit than what they need to pay in debt this year—the highest percentage in the consultancy’s history, which started in the first quarter of 2019. “It takes 18 to 24 months for the decrease in interest rates to affect companies’ accounts. So 2024 is still going to be a tough year,” stated Mr. Knoepfelmacher. He notes that 15% of these companies have leverage exceeding six times their cash generation. “More than three times is already considered a very high level with the Selic at its current level.”

Ricardo Jacomassi, partner and chief economist at TCP Partners, observes that companies’ cash flow remains very tight. “Costs have risen with the increase in the Selic rate and haven’t fallen yet. At the same time, sales performance hasn’t improved enough for cash generation to cover debts,” he explained. To alter this scenario, he suggests, revenues would need to return to their 2019 levels. A report by the company, which monitors 60 sectors, forecasts a 6% rise in requests for court-supervised recovery this year compared to 2023, when, according to data from Serasa Experian, reorganization filings surged by 68.7% to 1,405, the highest number since 2020.

Mr. Knoepfelmacher, however, points out that the indicators for court-supervised reorganization filings are not fully representative, considering the country has 21 million companies, almost 7 million of which have at least one overdue debt. “In a year and a half, many won’t be able to pay and will need to renegotiate their debts. Court-supervised reorganization is a bitter pill to swallow, with high costs for lawyers and administrators. We’ve handled 128 restructurings in recent years, and only 29 have been court-supervised reorganization.”

Mr. Jacomassi mentions that there has been an increased demand at the start of the year from companies seeking a buyer or partner to inject capital, in market terminology, the so-called “distressed M&A,” a situation also observed by Salvatore Milanese, founding partner of Pantalica Partners and an expert in company recovery and restructuring. He recalls that he used to prepare an average of three to four proposals a week. Since January, this number has escalated to eight to 10 a week. The demand is for diagnoses to extend debt and the pursuit of a merger or acquisition. Judicial recovery, he asserts, is the last resort. “In these cases, the sale of all or part of the company is not at the price the controlling shareholders would prefer, but it prevents the disastrous outcome of court-supervised reorganization.”

Mr. Milanese includes the call center sector in the list of sectors to be concerned. Mr. Jacomassi adds the hospital health sector, described as “highly leveraged and with tight cash flow,” along with the printing industry (label printing, etc.). He notes that agribusiness suffered due to the drop in international commodity prices, while raw materials had already been purchased at higher costs. “Improvement should only begin in November. We’re not optimistic for 2024.”

The study from Cemec reveals that after reaching its most recent high of 23% in the fourth quarter of 2021, the growth rate of financial expenses varied by only 0.1% in the 12 months ending in the third quarter of 2023. This calculation excludes Petrobras, Eletrobras, and Vale, as their size would skew the figures.

Simultaneously, the decline in cash generation is less severe: from -5.2% in the first quarter of last year to -1.7% in the third quarter. However, the gross profit margin (24.8%) was at its lowest since the 12 months ending in the first quarter of 2016, when it hit the same level.

Reflecting such a situation, the so-called financial expense coverage ratio has almost stopped declining, hovering around 1.8 for the 12 months up to the second and third quarters of 2023. This index reflects a company’s ability to cover the interest on its debts with cash generation and is calculated from the ratio of EBITDA to financial expenses. The higher this ratio, the more comfortable the company’s situation. Mr. Rocca clarifies that when it falls below 1, it indicates financial difficulties.

In 2019, around 11% of large and medium-sized companies (with revenues between R$90 million and R$300 million) had this index below 1, according to the Cemec report, which encompasses 337 companies. In the first quarter of 2023, amid high interest rates and a credit crunch, these percentages rose to 19.2% and 16.9%, respectively.

By the third quarter, following improvements in capital market conditions and the beginning of the monetary easing, the figure dropped to 14.5% among large companies, typically the first to show signs of improvement, indicating a potential return to 2020 levels. However, among medium-sized companies, the proportion of those unable to cover their financial expenses with cash generation remained high, at 20.7%.

“The expectation is that this index will continue to decline among large companies, but we have to wait and see, as there is considerable variation between sectors. Services, for instance, are still thriving, but industry and industrial retail continue to face challenges, unable to increase their margins,” notes the report.

Mr. Rocca anticipates a recovery in the availability of bank credit and debt securities in the capital market, coupled with expectations of relative stability in commodity prices and a decrease in financing costs from domestic and international sources. This trajectory is expected to continue with projections of a decrease in the Selic rate.

“We’re going to end the year with much lower interest rates and, by 2025, rates around 8%. This factor directly impacts a company’s results and is significant for cash generation,” said Daniel Lombardi, managing partner at G5 Partners. He notes that many companies have already restructured to reduce interest rates, while others are in the process of doing so this year. “The most uncertain factor is demand. We saw signs at the end of last year that things weren’t going well, with lower-than-expected sales on Black Friday and Christmas. However, demand should improve over the year,” Mr. Lombardi added.

Phillip de Macedo, partner and private credit portfolio manager, emphasizes that in this recovery scenario, the trend of turning to the capital markets is irreversible and increasing. “Last year was marked by credit events, and we started more cautiously. The credit scarcity eased over the year, and the crisis left clear lessons. Now, it’s a matter of calibration.”

*Por Liane Thedim — Rio de Janeiro

Source: Valor Intenational

https://valorinternational.globo.com/