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CAPITAL MARKET

High interest rates cause lower-than-projected profits for blue chips

The Slovak equity market kept its bearish mood during the past two weeks. Share prices remained stagnant and trading volumes were generally low. 1H97 blue chip company results showed their profits significantly lower than for the same period of last year (see story, page 1).
The main reason for the decline in corporate profits was the increase in financial costs caused by high interest rates. Companies without strategic foreign investors are experiencing decreasing profit margins resulting from stronger competition on domestic and foreign markets.
VSŽ, the Eastern Slovakia steel mill, reported 1H97 operating revenues of 28.1bn Sk ($802m), a 21% year-on-year increase. Operating costs increased by 34.2% to total 29.1bn Sk ($829m) implying a significant operating loss of 969m Sk ($27.7m).

The Slovak equity market kept its bearish mood during the past two weeks. Share prices remained stagnant and trading volumes were generally low. 1H97 blue chip company results showed their profits significantly lower than for the same period of last year (see story, page 1).

The main reason for the decline in corporate profits was the increase in financial costs caused by high interest rates. Companies without strategic foreign investors are experiencing decreasing profit margins resulting from stronger competition on domestic and foreign markets.

VSŽ, the Eastern Slovakia steel mill, reported 1H97 operating revenues of 28.1bn Sk ($802m), a 21% year-on-year increase. Operating costs increased by 34.2% to total 29.1bn Sk ($829m) implying a significant operating loss of 969m Sk ($27.7m). Financial costs increased by 65% and amounted to 1.37bn Sk ($39m) due to the increase in leverage and an overall increase of interest rates in Slovakia. Financial revenues increased from 583m Sk in 1H96 to Sk2.87bn in 1H97.

VSŽ's operating loss of 969m Sk being significantly counterbalanced by an increase in financial revenues is due to the change in the company's internal accounting methods. The company reported a net profit of 399m Sk ($11.4m), down 49% from the last year due to the low prices for delivery of products on long-term contracts. Given the strong recovery of the world steel market, though, we forecast a strong increase in net profits for 2H97.

The oil refinery Slovnaft reported 1H97 figures which are slightly disappointing. Operating revenues reached 20.6bn Sk ($589m) and the pre-tax profit was 1.46bn Sk ($41.7m) which translates into a net profit estimate of 874m Sk ($25.0m). The company significantly increased its leverage during last year which translated into financial costs of 4.14bn Sk ($118.6m).

The weaker than expected 1H97 profit figures were caused by regulated prices of petrol in Slovakia which did not match up the growth in crude oil prices. Furthermore, company profit was affected by the strong US dollar vis-á-vis the Deutsch mark as the company purchases most of its raw materials in dollars, while its sales are to a large extent denominated in marks. In spite of the lower earnings expectations at the current share price, Slovnaft remains cheaply rated.

Although the largest Slovak commercial bank, VÚB, reported a pre-tax profit of 305m Sk ($8.7m) for 1H97, we forecast that the bank will break even at the end of this year as we expect a considerable increase in new provisions on doubtful loans in 2H97. There is also continuing uncertainty regarding VÚB's privatization.

Commercial bank IRB incurred losses of 684.7m Sk ($19.6m) for 1H97. For the same period last year, IRB made a pre-tax profit of 3.2m Sk. This year's losses were caused mainly by continuing loan portfolio restructuring and the unfavorable development of interest rates on the interbank money market.

IRB created reserves for non-performing loans worth 833m Sk ($23.8m), and the net provisioning reached 129m Sk ($3.7m). These results indicate that IRB decided to continue its strategy of balance sheet cleaning via "managed losses" and we expect the FY97 results to be at the level of last year when the company made a loss of 1.36bn Sk ($42.7m). We expect the balance sheet cleaning to continue in 1998 as well.

Nafta reported 1H97 operating revenues of 1.56m Sk ($44.6m) - down 20% year-on-year. The decline can be attributed to the lower activation of drilling works and lower sales of fixed assets compared to 1H96. These items are included in operating revenues according to Slovak accounting standards. Accordingly, 1H96 net profit is only 220m Sk ($6.3m), down from 409m Sk ($11.7m) in 1H96.

The aluminum producer, ZSNP, had a consolidated pre-tax profit of 212m Sk ($6.1m) for 1H97, which is 4% less than in 1H96. Sales reached 5.6bn Sk ($160m), 21% more than in the same period of last year. Most of the production was exported to EU countries. This year's profit will be affected by the import surcharge which, if kept unchanged, could push up the ZSNP group expenditures to 100m Sk ($2.9m) by the end of this year and squeeze the net profit to less than 500m Sk ($14.3m).

ZSNP is currently unable to repay loans worth 3.2bn Sk ($90m) and it seems likely it will apply for inclusion in the government's revitalization program, which would increase the probability that the bank consortium that provided the loans would agree with a proposal to defer interest payments on the debt. If that doesn't happen, the company will be burdened with 200m Sk ($5.7m) of interest costs and the consolidated pre-tax profit will fall below 300m Sk($8.6m).

The wire producer Drôtovňa Hlohovec had a pre-tax profit of 35m Sk ($1m) in 1H97, below its projections. The low profit is attributed to the increase in interest rates and contributions to the EXIM Bank (1.5m Sk in 1H97) and the Fund for Foreign Trade Support (3m Sk).

Drôtovňa will be hit by the increase in electricity prices and could be affected by the newly-imposed import surcharge, though the firm already filed a request for exemption from it. If it doesn't get the exemption,

Drôtovňa will still be shielded somewhat by the weak currency in the Czech Republic, from which the company purchases supplies. In the long-term, we expect Drôtovňa to benefit from a high demand of Czech and Slovak construction industries and its margins should be positively affected by increasing production of high-value-added steel cords.

Slovenské Lodenice made a pre-tax profit of 32.1m Sk ($0.9m) for 1H97, a strong improvement to 1H96 when the company posted a loss of 34.8m Sk.

Prepared by ING Bank N.V., Bratislava branch in cooperation with ING Baring Securities (Slovakia), o.c.p.,a.s.

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