Historically low interest rates over the past decade and a half have made corporate debt seem like a tantalizing opportunity for businesses seeking to fund growth initiatives, acquisitions, or even to simply smooth out cash flow irregularities. However, as interest rates swing sharply in the opposite direction, what happens next?
Month on month increases in borrowing costs, and the 0.5% increase in interest rates in June, mean once-alluring corporate debt has morphed into a threatening liability, exposing companies to significant financial risks. The dangers are especially pronounced for companies that have become over-reliant on debt financing, as they may find themselves ensnared in a precarious cycle of debt repayment and refinancing that threatens their very survival.
The first danger lies in the increased cost of servicing that debt. With interest rates having jumped, so too does the interest expenditure associated with variable-rate debt. This added expense can drastically erode corporate profits, and even render a previously profitable operation insolvent. A corporation in this situation might have to divert funds from key areas such as Research & Development, capital investments, or employee compensation to meet its debt obligations, stunting future growth and potentially leading to a negative spiral of cutting costs and shrinking operations.
Another peril arises from the impact on credit ratings. As interest rates rise and debt servicing becomes more onerous, credit rating agencies may downgrade a company's credit rating due to the increased risk of default. This not only makes it more expensive for the company to borrow, it can also scare off investors, leading to a drop in the company's stock price. In extreme scenarios, the company may even find itself shut out of credit markets altogether, leaving it without a crucial lifeline just when it may need it most.
In essence, the compounding effect of rising interest rates and increasing corporate debt can threaten a company's long-term financial stability and growth prospects. With that in mind, Plimsoll, the UK’s leading provider of company analysis and industry intelligence has assessed almost 2000 niche market across the UK economy to find where soaring interest rates will have the biggest impact.
After the boon of the pandemic years, there are some structural and political issues within the UK’s pharmaceutical manufacturing market.
AbbVie and Lilly both leaving the VPAS scheme as a result of the government’s demands for 26.5% of UK sales to be paid back to the Exchequer. These soaring return payment rates, more than twice that of Germany, are starting to make the UK a much less attractive place to invest, especially outside the EU post Brexit.
R&D tax credits have also been withdrawn for smaller UK pharmaceutical companies as Brexit tore the UK from the Horizon research programme. As a result, the UK’s share of global R&D is falling with the UK plummeting from 4th in 2017 to 10th in the ranking for late-stage phase 3 clinical trials.
The increasingly unfavourable conditions in the UK sector have seen debts soar. According to the latest Plimsoll Analysis, loss making has become endemic with 1 in 10 manufacturers making a loss for the 2nd consecutive year. As a result of this squeeze on profit margins, 38% of the UK’s leading Pharmaceutical Manufacturers have seen a sharp rise in their debt position. That has then fed through into 27% of pharmaceutical companies being awarded a Danger rating by Plimsoll.
After Brexit, the UK quit the EU’s “Reach” chemical management system. However, there have been repeated delays to the introduction of a new UK equivalent after the government’s own impact assessment discovered it would cost the industry £2bn to duplicate the safety data already held in Brussels.
Mike Lancaster, the head of innovation at the Chemical Industries Association (CIA) recently said that “Having to duplicate work to build a UK database, would set the UK chemical industry back by almost a decade at a time of increasing global competition and limited resources”.
This new, post Brexit disruption coincides with a period of marked deterioration in conditions in the UK chemical sector. Persistent supply chain issues continue to delay orders and stubborn, ongoing inflation eats into margins as manufacturers struggle with diminished pricing power.
With increasingly gloomy predictions for the UK chemical sector, debts have increased year on year. According to the latest Plimsoll Analysis, 39% of chemical companies based in the UK have seen their debt position deteriorate. This reflects the worsening of market conditions as 11% of companies are reporting multi-year losses. As a result, just under a quarter of all British chemical companies have been awarded Plimsoll’s Danger rating.
Auto Parts Manufacturing
Increasingly at the mercy of an apparently laggard government, the UK auto parts market cannot “compete on a level playing field”. That is according to the boss of Unipart, John Neil. Recent US legislation has shaken the global order of manufacturing to the core. The Inflation Reduction Act and the Chips Act have taken even close allies by surprise with stipulations that manufacturing be done in the US.
The resulting response from the EU and Japan has left post Brexit Britain in an unenviable position with industrialists warning that the UK risks "standing on the side lines" and losing key manufacturing investments if it does not come up with a response.
However, despite both domestic and global economic challenges, demand for cars and parts has remained strong, soaring 26.9% year on year and up for the fourth month running. Can this demand last in the continued cost of living crisis and interest spike?
Despite this recent increase in demand, the UK auto parts market remains the most indebted major sector in the UK economy. Over 40% of companies in the market have seen their debt position worsen in the last 12 months. The number of companies posting multi-year losses is also the worst in the economy. As a result of recent issues in the market, over a quarter of the industry has been rated as Danger by Plimsoll.
Plimsoll produces comprehensive financial studies on almost 2000 different UK markets. We believe that spotting weaknesses in a company’s financial health early can reveal those most vulnerable to economic shocks. How many companies in your market are vulnerable to failure should further maladies afflict the UK economy?
Visit www.plimsoll.co.uk to search for your key market and see out how many companies have been rated as Danger by Plimsoll today.