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commercial risk outlook report - march 2016

SV Partners has released the findings of our first Commercial Risk Outlook Report for March 2016, providing an analysis of the current state of Australian businesses from an insolvency and overall economic perspective.

This Report analyses industries and regions within Australia where operating businesses are predicted to face financial hard times within the next 12 months. This Report also develops a multidimensional view of the drivers behind commercial risk for Australian business owners, while providing insights from a professional insolvency perspective.

The Commercial Risk data attempts to predict financial failure based on the likelihood of adverse events including external administrations, petitions to windup, Mercantile enquiries, defaults, bankruptcies, court writs and default judgements within the next 12 months. This commercial risk data is fundamentally based on bureau information over a 5 year period.

The Commercial Risk statistics in this Report are from the latest bureau findings from December 2015, predicting default activity for the next 12 months.

 

Key Findings

Nationally, the top 5 industries at risk of default within the next 12 months are:

  1. Construction
  2. Professional, Scientific and Technical Services
  3. Retail Trade
  4. Manufacturing
  5. Transport, Postal & Warehousing

Northern Territory and Queensland are indicating the highest levels of potential defaults statewide proportionate to the number of businesses with 2.8% and 2.4% respectively 

The top five areas where businesses are most at risk of default within the next 12 months are:

  1. VIC: Melbourne – Inner (2,552 businesses) - 2% of businesses in the region
  2. QLD: Gold Coast (2,027 businesses) - 3% of businesses in the region
  3. NSW: Sydney - City and Inner South (1,938 businesses) - 2% of businesses in the region
  4. NSW: Sydney - Inner South West (1,792 businesses) - 2.8% of businesses in the region
  5. VIC: Melbourne - South East (1,730 businesses) - 2.6% of businesses in the region
National Commercial Risk Analysis
Across Australia there are currently 2.34 million operating businesses. Of these nearly 50,000 businesses or 2.1% are expected to face adverse financial events within the next 12 months. Nationally, ASIC Insolvency Statistics indicate approximately 10,000 companies are placed into external administration each year. 

ASIC’s September 2015 quarter statistics indicate there was an 8.3% increase in external administrations from the previous quarter, with the Construction industry contributing 16.7% of all external administrations. The Business & Personal Services (Other) sector attributed to 41.2% of the total quarterly insolvency administrations. 

The Construction industry within Australia is most at risk of default, with nearly 7,000 businesses deemed to be ranked as a high risk of defaulting within the next 12 months. The Domestic Construction sub sector is the main cause of economic concern. This is due to a shift in home buyers opting for higher density dwellings, such as apartments and townhouses, as overall housing affordability continues to be out of reach for most Australians. A recent international survey by Performance Urban Planning Research Agency, Demographia, confirmed these concerns, ranking Australian housing prices as one of the most expensive in the world with median house prices more than 9 times median wages (12th Annual Demographia International Housing Affordability Survey 2016). The focus on new low density dwellings and renovations to existing homes has caused a decline in the need for housing construction. Despite these concerns, the industry in general is forecasting demand and revenue growth over the next 5 years. 

From the Bureau data, key findings were: 

  • The Construction industry indicates mature businesses (businesses in operation 10 years or more) are not exempt from financial hardship, with over 24% in risk band 1. Nearly 8% of new Construction businesses (entry level to 4 years in operation) are also currently facing financial hardship (see Table 1)
  • Figures indicate that large Construction businesses with over 100 plus employees could face collapse due to financial pressures, potentially giving rising concerns to the rate of unemployment within the sector in the near future (see table 3). Further to this, 4 key construction business with a turnover of $50 million or more are at highest risk of default (see table 1).
  • The Professional, Scientific and Technical small business sector (employees ranging from 1 to 9) are facing default. The commercial risk figures indicate that this will highly likely increase, as risk bands 2, 3 & 4 show significantly higher numbers comparative to larger businesses based on employee and turnover size (see table 4).
  • Entry level businesses from 1 to 4 years in operation within the Professional, Scientific and Technical sector are proving to be susceptible to higher defaults and risk of failure. Trending data also suggests that this will continue to occur reflective of the first 4 commercial risk bands. 
  • During January 2016, two major retailers, Dick Smith Holdings Ltd and Laura Ashley entered into Voluntary Administration. Retrospectively, commercial risk data in the December quarter of 2015 indicated 1 company with a turnover of $1 billion or more in the highest risk category of financial failure, followed by 1 company in the less than $1 billion but greater than $500 million risk band of financial failure. December 2015 figures also show that alarmingly, there are 3 more major retailers with turnover of $1 billion dollars or more in risk band 2 (See table 5). This implies further adverse impacts within the Retail industry with key retail players in financial distress. Also concerning, a further 11 retailers with turnover between $100 to $500 million, remain in the highest risk category of financial failure. ASIC’s September 2015 quarterly statistics confirm the retail industry has increased in external administrations, up 9.8% from the previous June 2015 quarter; and 
  • IBIS World Reporting, coinciding with market trends, suggest that the larger department store giants such as Myer and David Jones are finding it difficult to compete with online retailers in line with consumer purchasing preferences. The Report also suggests that the Consumer Goods Retail Industry will decline in growth over the next 5 years along with industry revenue.   

Key causes of high commercial risk:

The Profile of Insolvent Companies Summary Table (Table 2) within ASIC’s Report on Corporate Insolvencies 2014-15 indicates the top 3 nominated causes of failure are inadequate cash flow (or high cash flow use), poor strategic management of business and lastly trading losses. Notwithstanding ASIC’s report on these causes of failure, other factors that contribute to business failure include:

  1. Decreased profitability;
  2. Difficulty in accounts payable and receivable;
  3. Issues with obtaining credit from suppliers;
  4. Difficulty in raising additional borrowings;
  5. Increased possibility of default or insolvency.

Combatting the effects of financial business hardship may be actioned by:

  1. Vigilance in accounts receivable collections;
  2. Maintenance of accounting systems and regular reporting to enable informed decision making;
  3. Producing forward profit and cash flow budgets to assist in projecting future cash requirements and identifying possible problems;
  4. Decreasing expenditure by exploring all avenues and increase or maintain margins;
  5. Keeping a register of personal guarantees, ensuring personal exposure can be readily assessed;
  6. Considering asset protection strategy advice; and
  7. Considering an independent business health assessment. 

 

Australian Taxation Office Recovery Actions

Although recently it has been publicised that there has been a spike in ATO recovery actions and court applications to liquidate companies, the ATO’s Report to the Assistant Treasurer issued in July 2015, indicated that the overall debt recovery activities has stabilised, while insolvencies linked to Garnishee Notices have in fact decreased by 17.9%.

Type of Recovery Action 2011 – 12 (number of cases) 2012 – 13 (number of cases) 2013 – 14 (number of cases) Total (no. of cases) Percentage change over past 2 years
Garnishee Notices 0 429 352 781 -17.9%
Directors Penalty Notices 1955 1881 2039 5875 8.4%
Application Freezing Orders 4 11 4 19 -63.6%
Departure Prohibition Orders Issued 4 1 4 9 25%
Security Over Assets 21 23 36 80 56.5%

 

 

 

 

 

 

 

 

 

In the same Report, small businesses are listed as the main contributors to ATO collectable debt, increasing by approximately $2 billion in 2013/14. Nearly 7% of small businesses with a turnover of $500,000 or less per annum contributed over $9.1 billion of outstanding ATO debt in 2013/14. On average, this approximately increases by nearly $1 billion annually, predicting that small businesses that turnover $500,000 or less, will likely collectively owe the ATO almost $10 billion for the 2014/15 period.

With pressures on entry level businesses dealing with tax debt, it is understandable that entry level businesses are likely to have a lower survival rate. With a recovery rate of only 3.2% of the total debts from insolvency cases with small businesses, payment arrangements are considered a favourable resolution actioned by the ATO to attempt to maximise debt recovery.  

Although seemingly a preferable recovery action, one of the top complaints made to the ATO is that the payment arrangement requests/reviews are refused and there is not enough understanding of the individual circumstances relating to the debt owed. 

This Report from the Inspector General of the ATO also suggests that key stakeholders claimed the ATO should take proactive measures to ensure improved resolutions for the taxpayer and the ATO, including:

  1. Better anticipation of taxpayer debts and difficulties with payments with risk modelling;
  2. Punctual prompts to taxpayers with financial difficulties in need of professional assistance for restructuring, turnaround or external administration prior to debts arising or accumulating; and
  3. Incentives to taxpayers for prepayment of anticipated tax liabilities.

 

Queensland Commercial Risk Analysis

Regions in Queensland where businesses are most at risk of default

Number of businesses

On a state level, 2.4% of businesses in Queensland have the second highest national risk of failure as compared with the national average of 2.1% (see table 6). Queensland has a higher exposure to the Resources sector than many of the other states and as Queensland is a growth state in terms of population, it also has a higher exposure in the Residential Construction sector.  As a result, these sectors have a higher risk level in Queensland than in other states. 

The three regions within Queensland with the highest risk of financial adverse effects for businesses are (proportionate to number of businesses): 

  1. Logan (3.4% of businesses in region)
  2. Gold Coast (3.0% of businesses in region)
  3. Ipswich (2.9% of businesses in region)

Given the level of businesses currently in default and with the personal insolvency figures on the rise (28% increase) from the June 2015 quarter to the September 2015 quarter (Australian Financial Security Authority), these regions are predicted to face further difficult financial times. Specifically relating to the Gold Coast and in light of the Commonwealth Games in 2018, we may see over the next few years, property prices increase, employment stability, development and general economic benefits in the region.

With the recent news in January that major resources company Queensland Nickle entering into Voluntary Administration, continuing concerns are with the State’s high exposure to the Resource sector. Central Queensland (ranging from areas of Fitzroy, Outback, Mackay, Wide Bay (see table 10)) has a higher at-risk percentage than the national average due to its high exposure to the Resources sector, with figures showing at least a further 5 mining companies are at immediate risk of financial failure in the next 12 months.  With iron ore expected to remain below $40/tonne and coal below $60/tonne, this region appears unlikely to bounce back in the foreseeable future, according to leading resource analysts.  According to the Department of Industry, Innovation and Science, ‘Resources and Energy Major Projects Report’ released in October 2015, overall on a national basis, lower commodity prices and cost cutting resulted in a decline in exploration activity and expenditure. Queensland’s exploration expenditure remained steady at $1.1 billion. 

Industries most at risk of default within Queensland

Number of businesses

Consistent with national figures, House Construction, Real Estate Services and Management Advice & Related Consulting Services are all considered high risk sub sectors that are experiencing financial difficulties based on having the highest levels of defaults. 

Given the downturn within the Mining sector and the resulting fall in property prices with Northern and Central Queensland, business owners and their advisors are becoming vigilant in recognising key signs of financial stress. From our experience, business owners are now seeking more pre-insolvency advice and are taking a proactive stance to prevent business failure. The two main concerns for businesses are:

  1. Pressure from the ATO – the ATO has been more vigilant with their debt recovery and collection processes in recent times putting increasing pressure on small business. 
  2. Pressure from landlords – many landlords are yet to adjust to the marked downturn in commercial property prices and the economy by reducing rental costs. Leases and property deals entered into 2-3 years ago during the boom are now no longer viable, however some landlords have not been willing to be flexible and adjust to the changed economic conditions.  
New South Wales Commercial Risk Analysis

Regions in New South Wales where businesses are most at risk of default

Number of businesses

New South Wales as at December has over 17,700 business that will likely foresee unfavourable events such as defaults or external administrations within the next 12 months. This is 2% of the number of operational businesses in NSW. Proportionate to the national number of operational businesses within Australia, New South Wales is ranked 5th highest state in terms of businesses in the high risk category. Based on these figures, locations of major concern will be throughout Sydney City & Inner South, Parramatta and Sydney’s South Western regions.  Although proportionate to national levels, the State is experiencing the highest level of commercially risky businesses facing some level of financial failure in the next 12 months. 

Alike with these concerns for these commercially risky businesses, the number of actual businesses entering into external administration for the September quarter 2015, was 1,070, (36% of national insolvencies) a slight increase from the previous quarter (ASIC Series 1A Companies Entering External Administration, September Quarter 2015). 

Industries most at risk of default within New South Wales

Number of businesses

Construction Industry

Not dissimilar to national trends and predominantly due to the Housing Construction sub sector, the Construction industry within New South Wales alone contributed to 7.1% of total national insolvencies (19.7% of insolvencies for the State). The Construction industry in New South Wales is also set to face over 2,700 businesses under financial stress within the next 12 months. A further 5,700 construction businesses are also on unstable financial grounds being, in the second highest risk category. 

From experience, one of the main issues in the commercial construction space is with the management of project cashflow and adequate working capital. During a project lifecycle, funds are retained up the line by way of retention of monies, generally 10% up to a maximum of 5% of the contract value. In essence, for the first 6 months of a construction project, the builder or subcontractor is only receiving 90% of each claim made. The issue is then where the profit on a project for a builder or subcontractor is 10% or less, then in order to complete projects, the builder or subcontractor will be required to use their own working capital to complete the project. Unfortunately more often than not, they use creditors’ funds to complete the project, resulting in strained relationships, some creditors walking away from projects, project delays and the eventual spiral into insolvency.   

Housing Construction is the largest contributor to adverse financial outcomes reported for the Construction industry. Focussing on the Housing Construction industry, IBIS World Reporting states that difficulty in trading conditions over the past 5 years are due to fluctuations in housing investment and the increase of high density apartment constructions and townhouses. The report also suggests that industry employment will decline over the next 5 years. Larger building and construction players have been introducing more competition in the market across states potentially driving out smaller businesses.  The Australian Industry Construction Industry Forum also has recently indicated that residential building has hit its peak, whilst Engineering Construction is on a downward spiral. 

On a positive outlook, according to October 2015 IBIS World Report, the Commercial and Industrial Building Construction industry is making a recovery since the major downturn in 2010/11. As this sub sector is one of Australia’s largest, and with the increase in Commercial investment over the past 5 years, the industry is suggested to be leading an economic recovery. 

The Construction industry is not isolated in that the Professional, Scientific and Technical Services and Retail industries followed with high risk industries, with over 1,600 and 1,100 businesses respectively facing the same outcomes.  

Retail Industry

The Retail Industry in New South Wales, according to the Australian Bureau of Statistics as of November 2015, had a turnover of $8.3 billion (up $3.1 billion comparative to November 2014). After the post-Christmas retail boom, trending information from the ABS suggests that the Retail industry may experience a reduction in turnover to an estimated $6.5 billion.

Commercial Risk figures indicate that the New South Wales small business Retail sector will be the most affected over the next 12 months, with 494 businesses likely facing adverse financial events. 790 retailers turning over less than $1 million per annum will likely face possible external administration or in default. The September Quarterly 2015 ASIC Insolvency Statistics recorded 73 retailers have gone into administration for the State.

Causes of Financial Pressures

Factors that have contributed to financial strains on businesses in various industries include the following: 

  1. ATO pressures and further debt recovery actions as mentioned in the national section of this report;
  2. Online competition for retailers from an overseas consumer market;
  3. Consumer and economic factors such as consumer demand fluctuations and interest rates;
  4. Life cycle of businesses limited to innovation and growth with lack of capital to reinvest within their own business;
  5. Lack of business cash flow, typically stemming from late or non-payments from suppliers, decrease in gross profit margins and excessive expenditure;
Victoria Commercial Risk Analysis
The Commercial Risk analysis depicts significant financial risk for Victoria’s major employing sectors over the forthcoming 12 month period. Regions to be hardest hit include the Inner suburbs of Melbourne and Southern East Melbourne.

Industry and employment data compiled by the Australian Bureau of Statistics (ABS) provides valuable insight as to the geographical impact of risk to specific industries.

The table below depicts 4 industries identified earlier in our analysis, as being exposed to credit default risk and is assessed against Victorian employment data. 

Industry Victorian Labour Force Employed 
(%)
Melbourne Inner Labour Force Employed (%) Melbourne South East Labour Force Employed (%)
Construction 8.3 3.6 9.5
Retail Trade 10.8 9.0 11.2
Manufacturing 10.7 5.4 13.4
Professional; Scientific and Technical Services 7.8 19.0 6.7

 

 

 

 

 

 

 

Geographical Impact on Industry

Approximately 38% of Victoria’s Labour Force is employed in 1 of the 4 industries depicted above. Safe it is to say, the economic performance of the State is strongly correlated with the financial performance of these key sectors given:

  • Victoria has the largest manufacturing industry in Australia with approximately 30% of the country’s Manufacturing workers employed in Victoria. 
  • Of the 268,000 persons employed in the Construction industry in Victoria, 84% participate on a full time basis. The only industry producing greater full time employment numbers is the Manufacturing sector;
  • Valued at $285 billion (sales per annum) in 2014-15, of Australia’s total Retail market, Victoria’s makes up 25% ($71 billion); and
  • Around one third of all financial and insurance activity in Australia takes place in Victoria. Two of Australia’s four biggest banks, and hundreds of fund and investment managers, are based in Melbourne.

Regions in Victoria where businesses are most at risk of default

Number of businesses

When considered from a regional perspective, the risk analysis tells us:

  • Approximately 25% of the Labour Force of the South Eastern region of Melbourne are employed in either the Manufacturing or Retail Trade industries. Compare this to the Inner suburbs of Melbourne where only 14.4% of the Labour Force is represented in one of those industries. 
  • The risks correlate directly with employment data retained by the Department of Employment. For example, Victoria’s unemployment rate sits at 5.9%. The South Eastern region of Melbourne is recorded as having the 2nd highest rate of unemployment in Victoria at 7.7% (1.8% above the State average). Conversely, the Inner suburbs of Melbourne record an unemployment rate of 4.3% (1.6% below the State average). The data therefore provides assistance to understand better the basis and structure of unemployment on a regional basis;
  • Relativity is key. Inner Melbourne’s Labour Force is dominated with employment in Professional; Scientific and Technical Services. It accounts for 19% or almost 1 in 5 persons participating in employment in the Region and 25% of all persons participating in employment in the Professional; Scientific and Technical Services employment across the State. The only other Industry to attract double digit participation rates in Inner Melbourne is the Health Care and Social Assistance sector (10.3%). It therefore stands to reason that there is a greater probability that an insolvency event occurring in this sector will see it having occurred in Inner Melbourne. Further, industry risk in the Professional; Scientific and Technical Services sector will see the effects impact persons located in Inner Melbourne more than any other region. The same may be said of either the Manufacturing or Retail Trade industries in the South Eastern region of Melbourne where 25% of the Labour Force of there is employed in those 2 industries.

Alarmingly for the Victorian economy trend data attributable for these sectors points to at least some level of distress. Specifically:

  • Sales of goods and services (chain volume measures) in Manufacturing declined 5.3% in the September 2015 Quarter (when compared with the September 2014 Quarter);
  • The trend estimates for total dwellings approved fell 1.9% in November 2015 and has fallen for eight months. The seasonally adjusted estimate for total dwellings approved fell 12.7% in November 2015. Company gross operating profits fell 5.4% in the September 2015 quarter.

On a positive note, turnover in the Retail sector rose 4.1% in November 2015 compared to November 2014 and soon to be released data for the Christmas and New Year trading period should also reflect positively. There were also positive trend estimates in the September 2015 quarter in respect of company gross operating profits (up 2.8%). Whilst positive for some, notable collapses of retail giants such as Dick Smith Holdings Ltd; Laura Ashley and upmarket fashion label, Arthur Galan (administered by SV Partners) demonstrate the difficult and disruptive economic and operating environment conditions being experienced by retailers.

Government has a key role to play in both stimulating economic activity and facilitating restructure and reform. Initiatives such as the proposed East West Link tollway and the removal of up to 40 level railway crossings across Victoria are infrastructure led initiatives which will boost jobs and economic output, aiding the Construction sector in particular. Long awaited reforms to Manufacturing aimed at stimulating growth, competition and innovation whilst facilitating the efficient allocation of resources, are directed at reviving and reforming the Victorian Manufacturing sector.  

Industries most at risk of default within Victoria

Number of businesses

Conclusion
 

The SV Partners Commercial Risk Outlook Report analyses the overall economic conditions of business activity based on industry and location resulting from commercial bureau data. 

Those industries influencing the Australian economy including major sectors such as the Construction, Professional, Scientific and Technical Services and Retail sectors, are subject to the largest portion of businesses likely to go into default and/or facing levels of financial hardship within the next 12 months. Supporting the financial outlook of these industries is the level of companies entering external administration. 
Recently it has been widely publicised that the ATO has actioned stronger enforcement on small businesses to recover taxation debts. 

With consideration to the above information within this Report, we are able to assess those key factors that contribute to the forecasts and current conditions of Australia’s industry sectors.  

Glossary of key terms
 

Bureau - Organisation specialising in collating and analysing credit related information within Australia.

Bureau Data - Data is sourced from over 20 million commercial sourced records and data assets on Australian Individuals and businesses. Data sources include the Australian Securities Investments Commission, Business Directories, the Australian Bureau of Statistics, Consumer/Commercial Credit Bureau, Australian Post Office, Australian Business Register, Telephone Directories, Business Research.

Business Age Classification - as defined by Australian Business Register
Less than 1 year
1-4 years
5-9 years
10-19 years
20 years or more

Business Location - Business locations are the physical place of trade or operations.

Business Size Classification - as defined by Commercial Credit Bureau
SOHO - Small Office/Home Office
Micro
Small
Medium/Large

Commercial Risk - A behavioural scorecard for each commercial entity is based on bureau data from the past 5 years, taking into consideration enquiries or financial default. The commercial risk data attempts to predict financial failure based on the likelihood of adverse events including external administrations, petitions to wind up, Mercantile enquiries, defaults, bankruptcies, court writs and default judgements within the next 12 months. 

Default - Failure to meet financial obligations.

Operating Business - Business registered on the Australian Business Register, and are actively trading.

Region and Industry - Industry and Regional definitions are based upon the Australian and New Zealand Standard Industrial Classification (ANZSIC) codes.

Risk Bands - Ranks each business on a scale of 1 (high risk) to 10 (low risk) based upon their likelihood to default within the next 12 months.

Tables

Please download a copy of the Commercial Risk Outlook Tables.

 

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