Published: October 01, 2014
While French mid-market firms have adopted prudent financial strategies since the financial crisis, Standard & Poor’s analysts Claire Mauduit-Le Clercq and Alexandra Krief discuss how pressured competitiveness and stagnant investment levels are inhibiting France’s economic recovery, and how French midsized companies must seek alternative funding sources to fill the gap left by banking disintermediation.
Economic forecasts show that France is lagging behind an already slow European recovery – driven by an overall decrease in manufacturing output. This production loss – combined with a weak economy – means that French midsized companies are hesitant to kick-start investment programmes. Yet despite the absence of substantial funding growth, we predict that the French mid-market sector will need to raise around €690bn of debt in the next five years, mainly related to refinancing needs. And with ever increasing banking disintermediation, these firms will need to look outside to complement traditional sources.
One option is to tap private placement and direct lending markets, which have begun to help French midsize companies diversify their sources of funding. However, mid-market firms will need to improve transparency around their credit quality if they want to attract this kind of investment.
There are several factors contributing to weak economic growth in France. One factor is rising labour costs – up by 30% since 2000 – encouraged by the increase in the General Social Contribution (CSG) tax, which, in turn, has contributed to weaken French companies’ competitiveness, affecting the whole industrial base.
Severely hit during the economic crisis, manufacturing production in France is yet to regain its pre-crisis output level, unlike Germany which managed to by 2013. Indeed, last year France witnessed a decrease in manufacturing output of 0.9% year on year.
In addition, low investment levels are exacerbating the problem. Regarding the investment component of French GDP growth, we are expecting a low contribution of 0.8% at the end of 2014 and 1.4% in 2015, which is lower than elsewhere in the Eurozone. This trend can be explained by the relatively low importance placed on capital-intensive industries in France.
These factors contribute to the low growth expectation for France’s GDP of 0.5% by the end of this year, which compares poorly to expected growth of 1.8% for Germany and 3.1% for the UK.
Despite this sluggish economic outlook, prospects should gradually improve for the French mid-market. While the profit margins of French midsize corporates have been under pressure since 2007, these firms have displayed more conservative financial profiles than their peers elsewhere in Europe – providing robust cash and equity buffers as well as financial resilience during tougher times.
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Since the financial crisis, French midsize companies have been reinforcing their balance sheets by keeping their leverage as well as their interest expenses (through controlled debt level) under control. In addition, they have adopted prudent financial strategies, helping them to maintain high cash levels. Leverage patterns show that midsize French corporates average a lower debt-to-EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) ratio than their European counterparts (see chart 1).[[[PAGE]]]
In doing so, many midsize companies have maintained good credit quality. Adopting a cautious approach to financial policy means that 54% of French mid-market companies fall within the top three categories (MM1, MM2 & MM3) of the S&P Mid-Market Evaluation (MME) scale, used to assess creditworthiness (see table 1).
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But even with the large cash reserves held by these firms, we estimate that the French mid-market sector will need to raise between €650bn and €690bn of debt in the next five years to honour their financing commitments and fund growth. Meanwhile, limited transparency of financial profiles and less international diversification means mid-market companies – especially those on the smaller end of the spectrum – face funding issues. This is because banking disintermediation — where banks are providing less funding than in the past — is growing and will hold for the long term.
Private placement and direct lending markets are helping to alleviate the funding pressure faced by these businesses. Since 2011, French mid-market companies have completed 27 Euro Private Placements (Euro PP), four US private placements (US PP) and three German Schuldschein deals, raising a total of €1.7bn.
The Euro PP market is the preferred alternative funding tool for French mid-market companies (see chart 2). Research also shows that smaller issuers are expanding their share of the Euro PP market: larger issuers represented 84% of total volume in 2013, down from 96% of the total in 2012.
One of the main reasons behind the appeal of the Euro PP market for midsize companies is the growing investor appetite for yield and diversification in a low-interest rate environment. Currently, the standardised and well-developed US PP and German Schuldschein markets lend, primarily, to investment-grade issuers. In contrast, investors in the French Euro PP market are showing an interest in a wider range of credits, focusing on midsized companies with implied ratings of ‘BB’ or above, reflecting the growing appeal of this market for midsized issuers.
Aside from the private placement markets, direct lending is also helping the French mid-market to diversify its funding sources. For example, French asset manager Amundi recently teamed up with banks to provide financing for the French mid-market sector.
While private placement and direct lending markets are making ripples in France’s mid-market, there is still some way to go. Most importantly, greater transparency around individual corporate creditworthiness is needed for alternative funding options to become a comprehensive solution that spans the ratings scale and size spectrum.[[[PAGE]]]
The main problem is that, currently, investors favour larger companies because they lack detailed knowledge of the leading corporates in the small to mid-market. In response, smaller mid-market companies must seize this opportunity to attract investors by offering up the transparency they desire, a key aim of S&P’s mid-market credit benchmark, MME.
In spite of the challenges they face, we predict that with adequate funding from alternative sources, smaller mid-market companies could contribute more to boost the French economy in the future. And, despite the slow GDP growth forecast for France for the current year, S&P anticipates a small pickup in 2015 and steady improvement thereafter.
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