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CAPITAL MARKETS

Gloomy outlook for the Slovak corporate sector

The market declined by 4.8% during the last two weeks, and the SAX closed at 108.03. Pre-election uncertainty and secondary impacts of the Russian meltdown (i.e. corrections of expected earnings) were behind the losses. Slovakofarma was hit particularly had as the market discounted its exposure to Russia and weak interim results: The company's shares fell by almost 26%. The market is expected to remain subdued in the run-up to the election with risks biased on the downside.
Slovakofarma disappoints the market
Fundamental problems to be felt soon

The market declined by 4.8% during the last two weeks, and the SAX closed at 108.03. Pre-election uncertainty and secondary impacts of the Russian meltdown (i.e. corrections of expected earnings) were behind the losses. Slovakofarma was hit particularly had as the market discounted its exposure to Russia and weak interim results: The company's shares fell by almost 26%. The market is expected to remain subdued in the run-up to the election with risks biased on the downside.

Slovakofarma disappoints the market

According to a company press release, company 1H98 sales declined by 12.1% with all major markets recording sales declines. Sales in Slovakia (30% of total turnover) and the Czech Republic (55% of total turnover) both fell by 8.9%, and exports to other markets decreased by 22.6%.

Domestic health insurance companies have been facing liquidity problems, and so have been late in reimbursing pharmacies and hospitals. This has had a negative impact on total drug consumption. A mild winter also reduced consumption of seasonal pharmaceuticals.

Exports to the Czech Republic fell for similar reasons, but are also influenced by the fact that comparison is being made to 1H97 when the strong Czech crown vis-a-vis the Slovak koruna inflated company earnings .

The significant drop in exports to other markets is due to a sharp decline of sales to Germany (-55%) and Ukraine (-46%). Sales to Russia were126 million Sk ($3.6 million, or +6%) - representing about 5.4% of total sales. Gross profit fell by 21% to 944 million Sk ($27 million), and the gross profit margin deteriorated to 40.2%. EBIT was down by almost 40% to 413 million Sk ($11.8 million) and the EBIT margin fell to 17.6%. Net profit was 171 million Sk ($4.9 million), down by 30%, and the net profit margin declined to 7.3%.

Management forecasts of an overall 8% increase in 1998 Slovakia sales are optimistic. The company is also forecasting flat 1998 sales to the Czech Republic and a 20% decline in exports to other countries.The reported results are disappointing, and we expect the market will continue to react negatively to them. The company is heavily reliant on sales in the Czech Republic and Slovakia, and ongoing problems in those markets will continue to impact company performance. Investors are recommended to reduce their holdings of Slovakofarma.

Fundamental problems to be felt soon

A strong correction of earnings forecasts for Slovakofarma is the first indication of fundamental problems that the Slovak corporate sector is going to face in the next few quarters. The Slovak economy is following an unsustainable path, and even without emerging markets meltdown and irrespective of post-election developments, certain corrective events such as currency depreciation, fiscal austerity and economic slow-down are necessary and will likely occur in either 4Q98 or in 1999.

The currency depreciation and expected tight monetary and fiscal stance will cause substantial liquidity problems for the sector, and will force corporates to cut on their production and investment plans. Commodity sectors will be the first to feel the pinch, as plummeting world prices will erode their exports.

Later, other sectors will also be significantly affected as an economic slow-down will filter through into lower corporate investments and household demand. The Slovak economy is entering an era of significant economic turmoil, including a strong economic slow-down and corporate failures. The first signs of the upcoming problems can be seen already, and their consequences will be felt earlier than many might expect. The hey-days of the "Slovak economic miracle" are coming to a bitter end, and the days of reckoning are approaching.


Vladimír Zlacký is a securities analyst with ING Barings

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