Letter IEDI n. 856–Brazilian companies in the recent crisis
The IEDI continues to publish the studies that supported the formulation of its industrial strategy —to be announced soon; the works deal with topics such as taxation, infrastructure, financing of investment in the country, international integration, innovation, etc. The first one analyzed the transformations in the industrial structure between 2007 and 2015 (see Letter IEDI No. 855).
Today's Letter IEDI, in turn, analyzes the performance of non-financial companies, with special attention to industrial firms between the years 2010 and 2017. In total, 293 companies were surveyed and grouped into three macro-sectors (industry, trade and services), so that we could obtain a very representative sample of the Brazilian economy. The work is published in full on the IEDI website.
In the period of study, the overall economic picture was decisive for business performance. Following the 2009 recession triggered by the global financial crisis of 2008, the strong GDP growth of 2010 (7.5%) could not be sustained. In the subsequent period, from 2011 to 2014, modest results took turns with downright unfavorable ones, resulting in low average growth. For manufacturing the recession arrived early, in 2014, intensified and spread to the entire economy in the years 2015 and 2016. Only in 2017 would the economy grow again, but not with much strength yet.
This meager average growth after 2010, followed by a severe recession and a fragile recovery, formed the backdrop of a process of Brazilian companies' significant profitability contraction, debt increase and high commitment of operating income (EBITDA) with financial expenses. The study shows that, even with the end of the recession in 2017, such effects persisted, leading to the current scenario of a lack of investment dynamism and a weak economic recovery.
The companies' trajectory in each of the stages faced by the Brazilian economy can be summarized as follows.
The 2010 growth created very favorable conditions for companies. For full the sample, encompassing all sectors, net profit margin was 12.9% that year (8.5% for industrial companies, excluding Petrobras and Vale). The onerous net debt-to-equity ratio stood at 51.7% (62.1% for industrial companies) and the generation of operating income was able to cover 3.2 times the volume of gross financial expenses or 320% of gross financial expenses (2.3 times financial costs for industrial companies).
In the period of low growth (2011-2014) these indicators suffered a strong deterioration, indicating that Brazilian businesses entered the 2015/2016 crisis already weakened. Net margin declined progressively to a very low level: 1.9% considering all non-financial companies (3% for the industry without Petrobras and Vale). Indebtedness rose to 88.4% (62.7% for industrial companies, i.e. virtually unchanged) and gross operating expenses fell to 1.0% (1.4% in the case of the industry). That is, the generation of operating profit was only sufficient to honor the financial commitments, in the case of the full sample, and something close to that for the industrial companies.
The first year of recession was devastating for businesses. In addition to the rapid and very intense contraction of the level of activity, the rise in interest rates on domestic credit and the devaluation of the Real led to a large increase in indebtedness and financial costs. Net profit margin became negative for the whole set of non-financial corporations, falling to -3.6% (1.4% for industrial companies); net debt on equity increased to 115.5% (89.7% for the industry); and the generation of operating income covered only a small portion (30%) of gross financial expenses. For industrial companies, this last index was better, but still less than 1 (70% of gross financial expenses).
As the previous year's currency devaluation did not reoccur (on the contrary, there was appreciation) and the Central Bank initiated a phase of interest reduction, the second year of the recession, 2016, opened up an opportunity for the improvement of the businesses' indexes. The end of the recession in the following year allowed for a further improvement in the indicators. The relevant comment on the business indexes at the end of the period studied here (2017) is that some advances did occur but were, in all cases, small or even marginal.
Net profit margin improved for non-financial companies, reaching 4.0% and 3.7% for industrial companies (excluding Petrobras and Vale); in both cases the result was mainly due to financial expenses' reduction and to the lower effect of exchange variation in the 2016/2017 biennium. There was also a marginal improvement in the indexes of operating profit to financial expenses, as they remained slightly above the unit in both cases (1.2 and 1.3, respectively). As for debt to equity, the advance was small for the first group (99.7%) and practically did not happen for the second group (89.1%). The still very high interest rates on bank credit explain a significant portion of the slow readjustment of corporate profitability and debt.
The study also found that after 2011 investment contraction became practically constant, with the industrial sector leading the process, followed by the others —services and trade. This movement gains expression on the eve of the 2015 recession and extends until 2017.
The study showed that, for industrial companies (except for Petrobras and Vale), the return on invested capital (ROIC) has fallen since 2011, showing a more significant recovery only in 2017. Since there is no investment without the prospect of profit, this trajectory has a relevant role in explaining the reduction of investments. In the recession years of 2014 and 2015, the situation became even more adverse for productive investment because of the increase in the weighted average cost of capital (WACC).
For manufacturing enterprises, there was not a single year in the period 2011-2017 in which investment profitability exceeded the average cost of capital. Even the somewhat better level of profitability achieved in 2017 was well below what would be reasonable in relation to the average cost of capital. This finding suggests that there are still important obstacles to the resumption of a cycle of productive investment in the economy, a necessary condition for a sustained end of the recession.
In sum, the period under analysis ends with indicators of profitability, indebtedness and coverage of financial expenses below those recommended for companies to be able to turn the page on the recent crisis and start to invest again. This is a relevant determinant of the current low level of dynamism in the Brazilian economy.