Following several years of declining recuperações judiciais filings in Brazil, nearly 600 companies requested court protection in the first six months of 2023, a 52% increase over the same period in 2022.
Total filings remain below the number seen between 2016-2018, when Brazil went through one of its worst economic crises. However, there is a clear separation from the lower number of filings during the pandemic years of 2020-2022, when there was an increase in government support and creditors were more patient.
Recent filings include several high-profile cases (e.g. Americanas, Oi, Light, Grupo Petropolis) that have captured headlines in and out of Brazil. Less talked about are the increasing number of companies pursuing out-of-court restructurings. Certain industries, such as industrial products, construction, retail, and consumer products, have been hit harder than others. We expect this trend to continue over the next 12-24 months as the primary drivers of this activity will likely remain in place.
What is driving this activity?
The primary drivers of the increasing restructuring activity are declining profitability, higher debt service demands, and the resulting pressure that this places on a company’s liquidity.
Profit margins have been squeezed because of soaring inflation and higher raw material costs. Many companies have attempted to pass on the higher bills to their customers, often with limited success. Grupo Petropolis highlighted in its filing paperwork that it had only been able to pass on about 20% of the raw material price increases it had experienced since 2019, and even that modest effort resulted in lost market share.
Pre-pandemic and during COVID, capital was easier to access and many Brazilian companies loaded up on debt. With interest rates of 2% in 2021 this was not an issue, but over the last two years the Selic rate has jumped to 12.75%, dramatically increasing the amount of debt service for all borrowers, and even more so for those that are overleveraged. While the Selic rate did come down 50 basis points recently, stubbornly high inflation (3.99% reported in July 2023 is above the Central Bank’s target) may prompt policymakers to keep the Selic rate high in the near term.
A significant amount of debt, possibly as much as BRL 100 billion (USD 20 billion), is coming due in the next 18 months. Even more debt is scheduled to mature in 2025 and 2026. Companies will likely face a tougher time trying to refinance or extend currently maturing debt following the accounting issues that occurred at Americanas, as credit sources exhibit a lower risk appetite and also require increased transparency regarding corporate governance.
In addition to the current economic situation, foreign investors must continue to navigate well known barriers related to doing business in Brazil such as onerous labor laws, high costs of production, a complex tax code, and high levels of regulatory risk.
How can companies get ahead of these issues?
Our experience working closely with companies and investors facing challenging restructuring situations tells us both sides can take steps to avoid being caught up in an in-court or out-of-court restructuring.
Lenders can be focused on strengthening their up-front due diligence capabilities around a company’s financial and operating performance, validating that internal control systems are adequate and more closely monitoring the company’s situation by requiring more rigorous reporting during the loan period.
Companies must strive to improve their focus on instilling a true “cash culture” that prioritizes liquidity management. This would include implementing effective cash management systems and process with clear guidelines and responsibilities, a regular review of a reliable liquidity forecast (short-term and long-term) based on real-time information and identifying and implementing cash improvement actions. These actions could include reduction of operating costs through resizing the business or renegotiating key contracts, reducing working capital requirements, divesting non-core assets, and redefining how best to prioritize the allocation of available investment funds.
Although always difficult for companies, the increase in corporate restructurings also creates an opportunity for funds wanting to capitalize on opportunities created by the current market situations. In these situations, we can work with companies and investors to increase transparency, stabilize business finances, and improve company operations to preserve value.
Brazilian companies are suffering through soaring inflation and high raw material costs while facing tightening conditions to obtain credit. But even under the current economic situation, companies can take steps to alleviate the situation by having a strategic focus and being practical in their objectives and actions, ultimately creating transparency and regaining trust across all relevant stakeholders.
A special thank you to Dario Gaspar for his thoughtful contributions.