More than a quarter of firms in Europe and the Middle East have weak balance sheets, after companies loaded up on debt during the coronavirus pandemic and now face rising interest rates and soaring inflation, according to Alvarez & Marsal.
(Bloomberg) — More than a quarter of firms in Europe and the Middle East have weak balance sheets, after companies loaded up on debt during the coronavirus pandemic and now face rising interest rates and soaring inflation, according to Alvarez & Marsal.
About 28% of companies were considered to be in this category in 2022, while 8.4% were deemed to be in distress, the consultancy firm said in a report, highlighting the Middle East, Spain and Germany as the regions with the highest proportion of distress.
The number of firms showing balance sheet weakness is up slightly from last year, and 12% higher than pre-pandemic levels, according to the report. That reflects the amount of state-backed debt that companies received during the pandemic, and balance sheets now being increasingly stretched by hefty debt loads and higher interest rates.
“Companies’ ability to generate profits to pay for higher levels of debt is gradually being reduced,” the report’s authors, including head of EMEA financial restructuring Paul Kirkbright and managing director Alessandro Farsaci, wrote. Metrics such as net debt-to-Ebitda, debt service coverage and interest coverage ratio were the main drivers behind the weaknesses.
Companies have been buffeted by the 400-basis-point increase in the European Central Bank’s key rates over the last year as well as record-breaking inflationary pressures in the eurozone. With markets still volatile and investors more choosy, weaker borrowers have found themselves locked out of capital markets and less able to roll over existing debt.
The study included more than 7,000 listed and private companies with over €20 million ($22 million) of annual revenues across 33 countries in Europe and the Middle East.
Among sectors, non-food consumer businesses, media and entertainment and energy and utilities businesses were the weakest, the report said.
Businesses reliant on discretionary spending saw the percentage of distress rise to about 13% in 2022 from 8.5% the prior year, as rising mortgage rates and inflation ate into the disposable incomes of customers.
For energy and utility companies, the turmoil in Europe’s commodities markets had a “binary effect,” the report said. While some achieved higher operating margins following the surge in oil and gas prices, many utility companies struggled to pass on higher rates to customers. The percentage of gas companies in distress rose to 19% in 2022 from from 6.5% the prior year, according to the report.
On country-by-country basis, the authors pointed out that Germany could be “ahead of the curve” when it comes to restructuring activity due to tests around liquidity imposed by the country’s legal framework. In Spain, while there is a high proportion of companies in distress, levels have declined year-on-year, in part due a “spectacular rebound in tourism,” the report said.
Kirkbright and Farsaci see tighter financial conditions and recession compounding issues for companies this year. “We expect that tougher conditions will force more companies to actively pursue deleveraging and restructuring measures,” they wrote.
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