Newsletter 25, January 2009 (No comments so far)
Chemical Distribution in Central Europe: new troubles ahead
Will changing market conditions in the CEE impact distributors?During the last twenty years, many European chemical distributors had been attracted by the above average growth prospects and new opportunities which had been available to them on the emerging markets of Central European and Turkey. During the period 1997-2007, the Central European industrial growth rates were twice or three times as high as those reported in Western Europe. The CEE region growth rate is forecasted to be below 2.5 % in 2009 down from 5.5% in 2008. Previous growth rates averaged 6.3% per year over the last nine years (Source: RGE Monitor). Meanwhile, Germany which is their main trading partner is in recession. This reality combined with other EU countries’ reduced imports will further decrease their export contributions.
There was an additional attractive feature for chemical distributors to set up “grass root” operations there which was the lack of pre-existing modern CEE distributors and therefore less competitors than elsewhere. The previously centralized economic system left behind a few obsolete import organizations and some polluted sites which were not meeting modern environmental requirements. Western distributors with modern marketing concepts, good supplier relationships and site management skills were able to build and serve smaller but faster growing markets in need of distributors’ products and services. They very significantly contributed to the CEE industrial expansion. To day, the larger share of the CEE chemical distributor markets is held by German and other European chemical companies and a much smaller share by domestic players.
These known features of growth, high demand, need for services served those foreign distributors well until 2008. However what seemed to have been a long lasting attractive business environment is turning now for many distributors operating in the CEE to be a business and credit nightmare.
The 2009 new economic characteristics of Central Europe are the following ones:
- Drastic demand decline
- Declining local currency values
- Credit crunch
- Reduced credit insurance coverage
- Difficult challenges ahead
1. Drastic demand decline
European Chemical and polymer distributors are experiencing now demand drops from anything between 10% and 30% in volume. Combined with declining prices, we can expect that in 2009, most distributors and particularly the commodity chemical and polymer distributors will show sales drops between 20 and 40%, which is unheard of in the recent history of our industry. These demand and resulting sales drops are even more drastic for the CEE distributors, particularly when translated in Euro, since many CEE country economies are export driven and their local currencies are weak, at the exception of Slovakia and Slovenia which are within the Euro-zone and the Czech Republic, whose currency is relatively stronger than others.
The worst economic performances in 2009 are expected to be in the Baltic States and Ukraine, while the best performances will be seen in the Czech Republic, Slovakia and Slovenia. However, in November 2008, the Czech industrial output declined by minus 17% after a disappointing decline of minus 7% in October. Countries with large current account deficits notably Estonia, Latvia, Lithuania, Romania, Bulgaria and Serbia are most exposed to additional sharp currency corrections.
2. Declining local currency values
A large share of the sales made by distributors in the CEE, particularly for specialty chemicals, are purchased in Euro and US dollar and resold in local currencies. Distributors are thus exposed to the local currency fluctuations. Past currency hedging facilities are often restricted now as most bankers are reluctant to take additional currency risks in the CEE. The bankers’ “no risk” strategies are creating new financial difficulties which will only be resolved when the Banking community has solved their own internal problems which will still take a while.
On average, most Central European currencies dropped 20% versus the Euro between September and December 2008. The Hungarian Fiorint dropped 20%, like the Russian Rouble, the Ukrainian Hryvnia dropped 45%, the Serbian Dinar dropped 20%, the Polish Zloty dropped 24% and the Czech Koruna dropped only 14%. These declines exacerbated the financial risks for the distributors selling locally. Due to the recent losses caused by currency fluctuations and dropping demand, it is reported that several foreign owned distributors in the CEE are now facing some financial difficulties and are asking their mother companies to accept refinancing or recapitalizing them.
The problem is not so significant for smaller distributors operating in one or two countries as it is for bigger scale distributors operating in several ones. Each country has its specific problems and complexities, namely budget deficits, credit restrictions, currency weakness, customer credit issues, specific payment habits and terms, energy supply uncertainty, inflation rates, bad debts and delayed payments while distributors have no other choice than paying their suppliers and staff on time.
3. Credit crunch
Similarly to what is noticed to be the case for the chemical distribution service industry, most of the leading banks of Central Europe are subsidiaries of European banks, mostly German, Austrian, French and British. These banks are reluctant to overexpose themselves now in Central Europe and have put in place very strict selection criteria for new investments.
Their credit emphasis is on supporting past investments rather than pushing for new ones. It is also reported that several industrial sites in the paper, steel, textile or aluminum industries have shut down temporarily or permanently. Some of these investments had recently been financed with generous credit lines, which are now on the books of the lenders.
4. Reduced customer credit coverage
In 2009, credit and risk management are the main concerns of all distributors globally. In many European countries particularly in the South of Europe and also in Turkey, credit insurance institutions like Euler Hermes and Coface drastically reduced their credit coverage. It is estimated that this year, credit insurance companies reduced their coverage by 50% in Europe and particularly in the South of Europe and CEE. This means that distributors selling on open accounts are now bearing themselves the additional risks or are simply refusing to sell to risky customers. In addition to demand drops and declining currencies, this credit dimension is the most significant sales depressor on the more exposed and financially weaker Central European markets, including Greece and Turkey.
There is a simple reason for these drastic credit insurance limitations: Credit insurance companies are already overexposed on the CEE markets. They got cold feet after the AIG demises and their shares took a beating. For instance, Euler Hermes shares are at €28, down from €120 a year ago. The same holds true for Coface and other insurance institutions.
5. Difficult challenges ahead
For many distributors, Central Europe has been a goose laying golden eggs. Nowadays, the goose does not lay many eggs and needs to be fed properly before it hatches again. The directors and managers of local companies are turning to their mother companies for help. They are facing owners who are unprepared to cope with these unexpected financial problems and are reluctant to recapitalize their local companies, particularly as the problems in Central Europe are compounded by similar issues in Western Europe and in North America. It is more difficult now to transfer profits across subsidiaries. The most obvious solution seems to inject more equity into the local companies.
Investors and other Entrepreneurs have cold feet as the crisis is severe and could last longer than expected. This means that bail-outs could come in cascade and deep pockets might soon be empty. Privately owned distributors, whose patient owners manage costs carefully and have low debts on their balance sheets, will cope with this scenario without too much hassle.
On the other hand, some private equity owned distributors could eventually come into a squeeze between their bankers and the drastic market conditions. Their investors might request them to fulfill their financial obligations according to their credit covenants. In such instance, the company owners face a quagmire and could only have four solutions in front of them, namely hold tight, pay debts and overcome the crisis, recapitalize their ailing companies, renegotiate credit covenants or drop their CEE operations. They can only hope that the troubles in the CEE won't last too long and won't cost them too much, but who knows what comes next?