Despite the challenging macroeconomic environment, the Croatian blue chips have for the most part managed to improve their profitability. At the same time, higher loan interest rates resulted in higher interest expenses. In this quick overview, we look at the interest coverage ratio, one of the metrics of demonstrating the debt servicing dynamic.
Firstly, the interest coverage ratio refers to a ratio that shows us how easily any given company can service the interest on its outstanding debt. The ratio is calculated by dividing a company’s operating income, or EBIT, by its interest expense, during the observed period. The reason why this ratio is interesting to look out for is that it can be used as a gauge of the company’s risk level relative to its current debt, or any future borrowings. As such, a ratio lower than 1 shows us that a company’s operating profitability is not sufficient to cover its current interest payments, while a ratio lower than 1.5 indicates that a company might not be able to service its debt in the future. Naturally, a negative ratio also indicates that for that given period, the company is unable to service its debt.
One important thing to point out when looking at this ratio is the fact that comparisons between different industries do not provide an apples-to-apples comparison. The reason is the fact that some sectors use leverage (debt) far more often in financing their operations than others. Furthermore, due to the differences between industries, one level of debt might be suited for one industry, while it might be unsustainable for the other.
In terms of the Croatian blue chips, we analyzed all the members of the CROBEX10 index excluding HPB as it is in the financial industry which makes calculating this ratio unfeasible, and HT, which has no financial debt. To this, we also added Arena Hospitality Group and AD Plastik, which were previously in the CROBEX10 index, as we compare the data to 9M 2022.
Croatian blue chips interest coverage ratio (9M 2023 vs. 9M 2022, points)
Source: Companies’ data, InterCapital Research
Starting off at the top, Ericsson NT recorded an interest coverage ratio of 185x, representing an increase of over 100 points YoY. For Ericsson NT, the improvement came on the back of better operating profitability YoY, as the Company recorded 82% higher EBIT during 9M 2022, while at the same time, its interest expense did decline, but it is still negligible for a Company of this size, at EUR 133k. Next up we have Podravka, with a ratio of 43.2x, representing a decrease of app. 40.8 points YoY, due to its interest expense more than doubling to EUR 1.1m, while at the same time, EBIT improved by 6%.
Span also recorded a decline in this ratio, by almost 17 points, primarily due to a 36% decline in profitability, while the interest expense remained the same. For Adris, the ratio improved by 4.2 points to 26.8x, due to a 7% improvement in op. profitability, while the Company’s interest expense decreased by 10% to EUR 4.1m.
On the other hand, AD Plastik recorded an interest coverage ratio of -1.1x, meaning that on the 9M 2023 basis, the Company wouldn’t be able to service its debt. However, this marks over 47 points improvement from 9M 2022, as the Company recorded a 96% improvement in its EBIT, which stood at EUR -643k (9M 2022: EUR -17.9m), while it also recorded a 59% increase in the interest expense, to EUR 582k. Meanwhile, Atlantska Plovidba recorded an interest coverage ratio of 0.74x, a decline of 3.4 points YoY. This means that it could only partially service its interest during the 9M 2023 period. The reason why is primarily a 76% decrease in op. profitability YoY, while its interest expense grew by 37% to EUR 7m. Of course, it should be noted that Atlantska Plovidba recorded an extremely strong year in 2022 due to the shipping industry dynamics. This would refer to the fact that the prices of transportation due to supply chain constraints were extremely high for most of 2022. At the same time, in 2023 they mostly returned to pre-COVID-19 levels, due to the slowdown in demand due to high inflation and elevated interest rates.
What can be taken away from this? Firstly the fact that despite the challenging macroeconomic situation, companies managed to improve their profitability. The ones that didn’t, like Atlantska Plovidba, were more influenced by outside circumstances, and as such really couldn’t be blamed for the decline in profitability. On the other hand, interest expenses grew, which is to be expected as loan interest rates have increased significantly during 2023. Still, maybe the key takeaway is – for the most part, Croatian companies are continuing to operate in a challenging environment, and some of them managed to improve profitability. And lastly, most of them have double-digit interest coverage ratios, meaning that they would either have to experience a massive reduction in profitability, or a strong increase in interest expenses, neither of which is expected to happen at this point.