Looking back over 2018, the list of UK companies which have gone bust or entered into voluntary restructuring looks like the kind of Christmas reading only Scrooge would enjoy.

Although only a few of these were, or are, companies listed
on a stock market, the issues behind their problems are very relevant to the broader investment community.

Bench, Berketex, Byron, Carpetright (CPR), Claire’s Accessories, Coast, Conviviality, Crawshaw, East, Evans Cycles, Gaucho, Gourmet Burger Kitchen, Homebase, House of Fraser, Jamie’s Italian, Joe Bloggs, Maplin, Orla Kiely, Poundworld, Prezzo and Toys R Us are among the higher profile names to have experienced major problems. 

The damage isn’t limited to consumer companies. Contractor Carillion became one of Britain’s biggest corporate failures in January after lenders pulled the plug due to repeated contract delays and shrinking revenues. Rivals Interserve (IRV) and Kier (KIE) are currently in the middle of refinancing.

The main issue for these firms is failure to manage their cash flow. They typically use short-term funding to finance long-term projects. Once things get rocky, suppliers start demanding their money early and customers delay their payments, squeezing what meagre margins they have to breaking point.

ADAPT OR DIE

With consumer companies the main reason for their troubles
is a failure to remain relevant when web-based rivals are getting their customers’ attention and their money.

Maplin, a supplier of electronic components and already something of a high street dinosaur, went into administration in February 2018. Toys R Us, which operated from huge out-of-town warehouses, also shut its doors in February. Both had become obsolete in the new retail environment.

Other firms just failed to keep up with, or even acknowledge, rival technology. One famous example is Kodak, which failed to stay relevant in an age of digital cameras and smartphones. Kodak still exists, but has re-invented itself as a digital technology business.

Blockbuster, which at its peak had over 9,000 shops in 25 countries, was completely blindsided by the rise of video streaming services like Netflix and has faded away to a single store in the US where most visitors simply want their picture taken next to the shop sign.

CORPORATE FAILURES RISING

According to consultant McKinsey, corporate crises are not only occurring more frequently than they used to but they are also growing in magnitude. Typically the actual cost of a large corporate crisis is five to 10 times the original estimate.

Regulators in the UK and the US are pushing companies to write ‘living wills’ so that in the event of failure administrators can get on with the process of winding the company up. These wills even include details of who holds the keys to the building so that the administrators can gain access.

According to the Government’s Insolvency Service the number of UK companies put into liquidation by their creditors between July and September is up nearly 20% compared with last year and is at its highest level since the first quarter of 2012.

In the 12 months to September 2018 the construction industry had
the highest number of insolvencies followed by the wholesale and retail trade and vehicle-repair industry.

LEVERAGE BECOMING A MAJOR CONCERN

The Bank of England and the major credit ratings agencies are becoming increasingly worried about the amount of debt public and private companies are piling up and the potential for a wave of insolvencies.

In the notes of its latest Financial Policy Committee meeting the Bank of England warns that the issuance of leveraged loans has reached pre-crisis levels. It says most of the new lending has been used ‘to engineer changes in (firms’) liability structure to optimise returns rather than to fund new investment’.

It also warns that underwriting standards have loosened materially with ‘covenant-lite’ issuance at record highs while many of the borrowers are increasingly indebted. Most worrying, due to ‘add-backs’ that assume potential future earnings improvements, the actual amount of leverage is likely to be understated.

Credit agency Moody’s has warned of a ‘catastrophic’ rise in defaults due to the build-up of leveraged debt with terms on leveraged loans at their loosest ever in Europe. The looser the covenant, the worse the lender’s position is as it allows debt to be piled on top of debt.

KEEP YOUR EYE ON SUPPLIER CREDIT INSURANCE

One of the issues to monitor closely is credit insurers withdrawing cover to suppliers of certain companies. This happened to Debenhams (DEB) in the summer and more recently to Footasylum (FOOT:AIM). They do it when there are concerns that the end-company cannot pay its bills in full and on time.

Suppliers purchase credit insurance to ensure their losses would still be covered should a company collapse. The insurers either hike their prices or remove cover if it looks like a company could fall before it can pay its creditors.

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