Letter IEDI n. 1038–COVID-19 effects on businesses' balance sheets
Today's Letter IEDI analyzes the impacts of the COVID-19 crisis on the economic and financial performance of large non-financial companies in Brazil. Although there are important sectoral differences, the pandemic has not only compromised the level of activity of firms but has also brought down their profitability and reversed the already fragile deleveraging process of previous years.
Altogether, the balance sheets and income statements of 240 large companies were compiled, grouped into three sectors: industry, services and retail trade. Firms with the capacity to distort outcomes due to their size, such as Petrobras and Vale, or due to the great losses incurred, such as Braskem and Suzano, were excluded, generating subgroups. The same is true for electric power companies.
Based on data for the first half of 2020, the consequences of the pandemic on companies were severe. The crisis interrupted a trend of profitability recovery and debt reduction that had been happening in a sustained way since 2016.
For the total sample, the net profit margin went from 6.3% in the first half of 2019 to -5.1% in the same period of 2020. The operating margin fell by more than half. Net debt increased from 58.7% to 73.5% of equity. The exclusion of Petrobras, Vale, Braskem and Suzano in no way changed such deterioration.
In the industry, the reaction of profitability, which was already more timid in 2017–2019, was severely compromised: it went from 3.7% in the 1st half/19 to -2.2% in the 1st half/20, excluding the four companies above. Net debt went from 59.7% to 75.2% of equity.
The worsening in 2020 was mainly concentrated in the first quarter of the year. In the second quarter, there was some reaction due to the adoption of emergency programs by the government, the resumption, even if only partial, of some activities with the design of health security protocols and, at the end of the period, the progressive easing of social isolation.
The net profit margin, for example, left the negative ground of Q1/20 and returned to the black in Q2/20, although remaining very low. In the case of the industry, it went from -6.2% to +1.8%. For the total sample, the margin rose from -13.1% to +3.4%.
This improvement, however, manifested in a heterogeneous way. Basic inputs (generally scale-intensive) and capital goods companies, whose markets require positive expectations and adequate financing conditions, presented the weakest recovery. Their profits remained compromised by the economic activity reduction caused by the pandemic.
In general, the recovery of companies' net profit will remain a challenge. Even in an environment of lower interest rates, such as the current one, the increase in indebtedness and the currency devaluation resulted in higher financial costs. It is worth remembering that a lower currency value also raises production costs for those activities that are more dependent on imported inputs.
In the total sample, financial expenses jumped from 5% to 13.1% of operating revenues between the 1st half/19 and the 1st half/20. In the case of the industry (except Petrobras, Vale, Braskem and Suzano), they went from 2.6% to 7.7% in the same period. There was an improvement in Q2/20, but the high level remained: 7.6% for the total and 4.1% for the industry.
The EBIT/Financial Expenses indicator, which measures the degree of coverage of financial expenses by operating profit, decreased from 1.6 to only 0.4 for the total of companies analyzed and from 1.4 to 0.6 for the industry. In Q2/20, with the exception of services (energy excluded), all the others saw this indicator return to levels above 1.
High indebtedness and higher financial costs make a path of consistent and robust economic growth in the post-pandemic period all the more fundamental, in order to generate sufficient revenues to manage companies' liabilities and restore their profitability.
These are necessary conditions to create an investment-conducive environment, but also to avoid major equity problems for firms, given the growth of short-term liabilities.
The 240 firms' short-term total debt rose +45% from the first half of 2019 to the same period of 2020, that is, more than the +39% expansion in total debt. In the case of the industry, these increases were +37% and +46%, respectively.
Such figures for the industry as a whole, however, hide very large asymmetries across branches. Short-term debt advanced substantially in sectors such as aeronautics (+624%), footwear (+333%), metallurgy (+258%), clothing (+134%) and auto parts (+117%). Only the return to economic growth will allow these commitments to be met without obstacles.