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Jun 2018

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Trade credit insurance: Loosening days sales outstanding

Source: Asia Insurance Review | Jun 2018

Trade Credit

Messrs Marc Livinec and Mahamoud Islam from Euler Hermes take a close look at the return of growth and trust and how they distract attention from days sales outstanding (DSO).
 
 
Over the past 10 years we have observed a clear correlation between days sales outstanding (DSO) and global economic growth. The financial crisis of 2007-2008 had led companies to monitor closely or accelerate debt collection, reflected in the sharp fall in DSO (-5 days, to 60 days in 2008 on average). 
 
   The return of growth then allowed DSO to rise to 64 days where it stayed constant from 2012 to 2016 before the backdrop of +2.8% pa average GDP growth. We interpret the latest increase in DSO as a certain lowering of the guards and greater trust as a result of stronger growth and optimistic short-term macroeconomic forecasts: GDP growth reached +3.2% in 2017, after +2.6% in 2016. We expect a similar dynamic in 2018, with global DSO rising by one more day, to 67 days. 
 
Widespread lengthening of payment periods
Across our sample of 25,000 listed companies across 20 sectors and 36 countries, DSO rose by +2 days on average globally, reaching 66 days at the end of 2017. After five years of stability at 64 days, DSO reached a 10-year high. 
 
   The lengthening of DSO reflects a relaxation of payment standards between companies. As global economic health is improving, companies tend to trust their clients to pay them latter – despite the increase in insolvencies at large corporations.
 
   The increase in average DSO in 2017 stems from a global trend observed in most countries. For the most part, they are developed countries, but some are large emerging economies, such as China (+3 days) and other Asian countries, but also Turkey (+3 days) and Brazil (+1 day).
 
   In light of relative levels of DSO, three main groups of countries emerge with respect to the global average:
  1. The seven strongest countries have an average DSO inferior or equal to 51 days, the country with the lowest DSO globally being New Zealand with 43 days. Other countries with short averages are the Nordic countries (Denmark and Finland), Austria and Switzerland, the US and eventually the Netherlands despite the four-day rise due to the strong increases in the telecom, technologies and support services sectors.
  2. The group of seven other countries for which DSO stays below the global average, comprises amongst others Germany (54 days), Canada (54), Brazil (62) and the UK (53) in which it is stable despite uncertainties due to Brexit. We find it noteworthy that Russia is part of the group, with DSO decreasing by +2 days to 56 days, with one quarter of companies being paid under 22 days.
  3. Finally, the remaining group of 12 countries with an average DSO superior to the global average of 66 days, such as France (74), Italy (83). China has the highest average DSO (92 days). With respective average DSO of 74 days and 83 days, Portugal and Turkey should be closely monitored as almost one company out of four is paid after four months in these two countries. 
 
General heat map for 2017 DSO
 
Average DSO grew in two-thirds of the countries, being above average in both construction and upstream industrial sectors
We note increasing DSO in almost all sectors while four sectors particularly stand out: aeronautics (+4 days in 2017, +12 days since 2012), automotive (respectively +3 and +7), construction (+3) and electronics (+3), the sector with the highest a DSO in our universe. There are only four sectors with stable DSO (food, household equipment, machinery, recreational goods) and two with decreasing DSO y-o-y (pharmaceuticals and support services). DSO is once again far higher in B2B than B2C activities.
 
   The longest DSOs are in sectors with long manufacturing processes, ie, aeronautics (72), automotive (72), machinery (87) and electronics (91). DSO in all of these sectors exceeds the global average of 66 days by +6 days or more. 
 
   This is also the case for chemicals, with a DSO of 73 days on average. It is no surprise, as it is a supplier to all industrial activities.
 
   Construction is one of the three sectors with the highest DSO with 85 days: this stems from public works and infrastructures, but also from increasing delays in real estate programs. Not overly surprising given the heterogeneous nature of the sector, there is great divergence around the mean.
 
   DSO in the energy (63 days), metals (58) and paper (62) sectors stand below our global average. However, the metric for the two former increased by +3 and +2 days in 2017, respectively, as a consequence of the increase in commodity prices. As for the paper industry, the +1 day increase to 62 days can be explained by the rise in online sales.
 
   Finally, pharmaceuticals is the only B2B sector with a decreasing DSO (-2 days) in 2017, albeit still with (78 days), linked to its particular customer base – mainly public health insurance systems.
 
   At the other end of the spectrum are sectors closer to the end consumer, with DSO far lower than the global average of 66 days, such as food (46 days), transportation (49) and household equipment (49).
 
China: three sectors to monitor closely
China’s DSO reached a 10-year high in 2017 (at 92 days). Not only does it have the highest number of DSO in our sample (with an average of 92 days) but the trend is upward: it increased by +3 days compared to 2016. We see two reasons behind this trend. First, Chinese listed corporates are becoming more and more global and they follow the rise in global DSOs. Secondly, intercompany credit is one of the main alternative sources of financing since the government tightened access to bank credit. 
 
   Against this background, we see three sectors that should be monitored closely: construction, machinery and equipment and basic industrial materials where DSOs are relatively high compared to global average. These sectors are adjusting as part of China’s rebalancing process - deleveraging in old economic model and highly leveraged industries, cut in overcapacity - and considering their already high level of leverage and DSO, a rise of DSOs should be watched carefully as it could signal rising financing difficulties. A 
 
Mr Marc Livinec is Euler Hermes sector adviser and Mr Mahamoud Islam is economist for Asia.
 
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