Going under: prognosis negative

Limited liability companies, by definition, enjoy the freedom of declaring bankruptcy if and when fundamentals of business turn materially adverse, without affecting the fortunes of the sponsors and shareholders. Why then b-word is such a taboo in Pakistan’s corporate sector, especially when macro variables appear to be pushing firms into going under?

For two reasons. One, even if a listed business is concentrated within sponsor family and has negligible shareholding with general public, declaration of bankruptcy is bad omen for other listed players in the sector, as investors may dump sector-stocks across the board. Two, while sponsors/management can always decide to cut their losses by calling it quits, declaring ‘game over’ has implications for their banking relationships, especially other commercial interests of the sponsor group which may be doing nominally better. Business families know well that when it comes to bankruptcy, hell hath no fury like a ‘banker scorned’.

Yet, dark clouds seem to be circling the industrial sector of the economy, with one business leader projecting LSM contraction over 6 percent for the ongoing FY20 period in a recent TV interview. One sector in particular seems to have been affected most by the economic downturn: sugar.

Let’s recap. Of the 89 odd sugar mills in the country, only one-third or 31 are listed. Of these, four have been defunct for more than one financial period, not even putting out interim or annual financials. Of the remainder 27, declaring 10 units as ‘sick’ is scary business, especially considering that little to nothing is known of the financial health of the non-listed two-thirds of the industry.

The accompanying illustration tables show listed companies weathering the toughest of tidings. The analysis has been prepared based on last available full-year financials. Factors indicating worst health range from qualitative factors, such as poor sucrose recovery when compared to regional averages. Others include number of operating days, which for sick units averages below 100, compared to industry average of 120 days in MY18.

Similarly, financial indicators also add elements of subjective judgment by looking at level of sponsor support relative to total external financing repayable. Losses on gross level are also hardly a good sign, neither is a negative tried-and-tested debt coverage status indicated by ratio of EBITDA to debt repayments in current period. Borrowing spread over two percentage points at a time when Kibor is already hovering over 13.5 percent offers little hope either.

Nevertheless, the indicators are no final recipe. Other subjective elements, such as past instances of strong sponsor commitment (for example, in case of Dewan and Premier) may give reason for optimism.

While some units have already been put up for sale since end of last financial year (e.g. Imperial), others have already been taken over by more aggressive business groups (e.g. Baba Farid by Thal group).

Overall, it can be safely concluded that when over one-third of an industry (albeit among listed units only) is struggling, that’s hardly a good sign for a sector.

Whether this leads to a phase of consolidation or pleas for a government bailout, only time will tell.