Credit where it's due

By Hayley Brown

- Last updated on GMT

Related tags: Credit insurance, Pension, Food and drink federation

Credit where it's due
If cash flow is the lifeblood of a business, what happens when the cost of borrowing goes up and less credit is available? Hayley Brown reports

Over the next few months The Bank of England intends to pump up to £150bn of new money into the battered economy. Love the idea or hate it, these extraordinary measures indicate the extremity of the economic crisis. And, although it is generally felt that the food and drink industry has not been hit as hard as other sectors, there have still been victims.

The cost of borrowing, the credit freeze and the issue of credit insurance have resulted in a wave of redundancies and factory closures. Manufacturers have also resorted to unconventional measures to reduce debts and renegotiate lending facilities, as well as enforce cutbacks in investment and new product development projects. In extreme cases, it has even been suggested that the number of factory fires jumps up in times of economic hardship, says Peter Jackson, technical director of International Fire Consultants.

"The brakes remain firmly on corporate expenditure while companies seek to cut costs in the wake of the economic crisis; and it is employment costs that remain under the spotlight," says Malcolm Edge, head of markets for KPMG, a business advisory service.

According to the Food and Drink Federation (FDF), there have been around 3,000 job losses since January. Vion cut 820 jobs, while further factory closures threaten 180 jobs at Greencore, 245 at Gibsons Foods, 400 at Findus, 80 at Noble Foods, 94 at Kerry Foods, 300 at Tulip International and 130 jobs at Arla.

Thorntons recently said it was going to undertake a £1M capital investment to introduce a second flexible packaging line to its factory in Derby, with the aim of reducing labour costs by about 30%. But, in other cases, major projects have been shelved due to a lack of credit. "A combination of tighter bank credit and the current economic conditions are prompting some members to put investment decisions on hold," says Charlotte Lawson, member services director for the FDF. Butt Foods, for example, says that it has been forced to put two of its capex projects on hold.

Debts and deficits

But manufacturers have not only been reducing outgoings - in some cases, they have been forced to revisit their borrowings. Last month, for example, Uniq disposed of one of its loss-making businesses. The "net proceeds from the sale [of Pinneys of Scotland], after costs, will be used to reduce bank borrowings", says Uniq. Pinneys of Scotland was bought by The Seafood Company, part of the Foodvest group, for approximately £1M. One analyst suggests that the transaction, however, will "not be enough" to ease the group's debt pile and predicts that more disposals from the company may follow.

The arrangement fees for accessing new credit are also acting as an extra burden on manufacturers. In March, Premier Foods extended its banking facilities until December 2013 to give it more financial headroom. It also sold a 10.3% stake to a US private equity company Warburg Pincus, as well as undertaking a £400M equity issue. The deal is believed to have cost up to £80M to arrange. The food giant is also paying high interest rates on borrowings at 8.1%, according to Graham Jones, analyst at Panmure Gordon.

Adding to the group's debts is the deficit of its defined benefit pension schemes, which had a combined deficit of £153.7M in June 2008, an increase on the deficit of £123.2M in December 31, 2007. Sharp falls in equity markets are causing the majority of defined benefit pension scheme deficits to grow at unprecedented levels. In February alone the deficit of the 200 largest privately sponsored pension schemes in the UK soared by £16bn to reach a collective £45bn deficit total, according to Aon Consulting. So while the food and drink companies strive to become more automated and slash the numbers of workers employed to help reduce costs, their pension deficits - and therefore, debt - continue to grow. "If the number of people that are contributing to the pension pot decreases, then there are fewer people paying off that deficit," says Ben McDonald, pensions partner at KPMG.

Altium Securities, an investment advisory company, published a 'sell' rating on Britvic's shares after analysing the drink group's pension fund and debt. It noted that 55% of the fund's assets were invested in equities and only 1% in cash. Furthermore, says analyst Wayne Brown of Altium Securities: "The £300M revolving credit facility needs to be refinanced in 2009, which, in the current environment, is no easy or cheap task, as we anticipate net debt will rise to £408M by year end."

Brown says that Britvic is in a precarious situation in the UK and Ireland, and "we feel that continued pressure by retailers to offer customers better value for money could further pressurise margins, not least through greater emphasis on own-label products at the expense of the higher priced branded alternatives"

The drinks giant reduced advertising spend by about £5M last year and, more recently, it announced a strategic business review for its Irish business that will result in around 145 redundancies, according to Altium Securities.

Quantifying risk

Given the state of the economy, it is becoming increasingly important to quantify the impact of risks associated with the economic downturn, says Edge.

"We are asking clients to consider more extreme situations - for instance, what would happen to your business if your sales fell by 50%? What if your biggest supplier became insolvent? Some of our clients may think we are being overly dramatic, but we are only asking them to model scenarios that are actually happening across the marketplace," adds Edge.

One area where firms are having to re-evaluate risk is removed or reduced credit insurance cover. With a predicted 50% rise in the number of insolvencies over 2009, this means that insurers are having to act more prudently to "maintain their own financial health", says the Association of British Insurers. This has created a situation where manufacturers are not getting adequate cover and so the FDF has written to the government urging it to take action on the issue of credit insurance, "as it was hindering competition in the industry"

Credit Insurance problems

The insurance not only covers manufacturers and suppliers against customers that go bankrupt, but it also protects against late payments. For small and medium-sized enterprises (SMEs) it is estimated that the cost of late payments in 2008 jumped 40% to reach £26bn, according to last month's data from Bacs - the industry body responsible for the processing of more than 5.5bn payments a year, which is owned by 15 of the leading banks and building societies. Bacs says that SMEs are waiting an average of 41.5 days beyond agreed payment terms for invoices to be settled.

"With the increasing instances of supermarkets deferring their payments to suppliers, credit insurance is essential to reduce liabilities and limit damages to trading relationships," says Elizabeth Jenkin, business development director at insurance broker Aon.

As many as a third of UK businesses pay for services late (32%), according to the Forum of Private Business (FPB). Diageo and Anheuser-Busch InBev was recently 'named and shamed' after both imposed extended payment periods on existing contractual agreements with smaller firms, says FPB.

"Many companies are attempting to create artificial credit lines by squeezing their suppliers," says FPB spokesman Phil McCabe. He warns that, for SMEs, the "already steep cost" of loans and overdrafts increased in February and they were, on average, priced at more than 6% above the Bank of England lending rate. But these are the lucky ones, he says, as many firms have had their overdraft facilities withdrawn. "If a business cannot obtain credit, and at the same time is not being paid within a sustainable time period or subjected to enforced discounts, the consequences can be fatal," McCabe adds.

So the government's stated plans to launch a package of measures to help firms deal with the issue of credit insurance cannot come soon enough for many manufacturers. But some are sceptical about what it can achieve. One industry spokeswoman noted that other governmental measures to help stimulate bank lending had not filtered down to UK firms yet.

Her sentiment is reflected in KPMG's quarterly National Business Confidence survey published last month, which found that more than half (51%) of businesses were experiencing tighter borrowing requirements, 41% had seen an increase in the cost of credit but - more worryingly - around 87% of them said the economy would get worse before it starts to get better.

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