Economics and finance in the metalworking sector:
an empirical analysis on the enterprises in the province of Modena 2005-2008
The metalworking sector represents an extremely important reality for the Modena economy. The dense network of mechanical skills that characterises this territory has not only allowed the companies themselves to take a strong position on a global level in niche markets, but has also been decisive for the development of other local production systems, such as ceramics and biomedical.
The Metalnet 2005 research analysed various aspects of the company’s reality (ownership structure, activities carried out, outlet markets, level of vertical integration, etc.) showing a solid sector. In this context, different companies, linked by strong interdependence relationships, in the years 2004-2007 tried to face the challenges posed by globalization through important investments, especially in innovation and internationalization.
Subcontracting companies, each specialising in a specific processing stage and active in different target sectors, play a key role. These companies have focused mainly on two directions: first, on improving the service and offering an increasingly complete product. This gave a further impulse to the relations between the companies in the cluster, as it made it necessary to decentralize some work necessary to complete the production cycle to other companies, on behalf of third parties. This strategy responds to the need to offer the customer a product that is as personalised as possible and of the highest quality, for which he is willing to pay a premium price. The systemic dimension seems to favour the growth of companies that, within the Modena mechanical engineering cluster, find opportunities for vertical disintegration and productive specialization that favour the innovation processes of the companies in the cluster and their competitive capacity.
However, the picture that emerges from Metalnet 2005, appears to be in contrast with the findings of a study conducted by Banca Intesa (Foresti, Guelpa, Trenti 2009, “Cluster effect: does it still exist?”, Servizio Studi e Ricerche, Intesa S. Paolo) which outlined prospects that are anything but positive about the future of cluster companies.
Erica Poli's graduation thesis compares the results obtained in the Metalnet 2005 research with the balance sheet data of the same sample of companies, highlighting a picture that departs significantly from the study of Banca Intesa, which indicated that the cluster effect had disappeared.
In view of the changes in the competitive environment that characterised the economy and markets in recent years, especially the increasing competition from countries with low labour costs, Erica Poli examines the economic and financial conditions of the companies of Modena in the years prior to the outbreak of the financial crisis in August 2007. The analysis investigates the differences by size, type of company (own account, third party account, services) and by sector.
The survey covered a sample of more than 200 metalworkers in the province of Modena interviewed in the Metalnet 2005 survey. For this reason, we analysed the financial statements for the three-year period 2005-2007. For some of these companies, since the financial statements for 2008 are available, it was also conducted an analysis of the first effects that the crisis had on the company's economic results.
Within the sample, most of the companies only made available shortened financial statements, on which it is not possible to carry out in-depth analyses. This made it necessary to divide the analysis into two parts: the former was carried out on the entire sample, the information can also be derived from shortened financial statements, based on a reclassification of the balance sheet of a financial nature; the latter concerned only part of the sample, i.e. those 97 companies for which the balance sheet is available in full form, thanks to which the results obtained on the entire sample were supplemented with more complete information. In this case, the balance sheet was reclassified according to the functional criterion.
Summary of the main results
From an initial analysis carried out on the entire sample under investigation, it is possible to draw some interesting stating points for reflection.
Short-term investments play a significant role in the capital structure, especially loans, which represent most of capital investments.
Moreover, it is confirmed the low capitalisation of companies and the considerable use of debt (especially in the short term) to meet their investments.
Overall, however, businesses show a good financial balance.
This financial structure is also precise in the disaggregated analyses, namely there are no significant differences that upset the global picture. However, there are differences, which are more evident in terms of size and type breakdown.
What actually expresses the state of health of companies, on the other hand, is the analysis on profitability.
The sector ROE reaches median acceptable levels (7.01%) and so does ROA (5.73%).
The ROE is affected by the weight of the tax component and financial charges, which have a multiplier effect on the overall result of operations.
Overall, it would appear that the companies in the sample, although they do not obtain overly brilliant results, they do not even report pathological situations.
The breakdown by size class, type and sector also highlighted some interesting aspects.
One of these concerns the performance of small companies, since they have a high ROE value. This result does not derive from extraordinary or extra-operational components, but is strongly influenced by good sales margins and an efficient use of capital. All this leads to a better return on investment than the others.
Finally, these companies bear less of the cost of indebtedness and taxation.
On the other hand, larger companies not only show lower ROA values on average, but also suffer from a higher incidence of taxes and financial charges on average.
The second result obtained concerns the performance of service companies. According to the data, operating in the supply chain as a service and maintenance provider leads to higher ROE values.
Even though they are on average more indebted companies (as evidenced by the lower weight of equity on total sources), they are not excessively affected by the burden of financial charges. In addition, they manage to achieve the best result despite the higher tax burden.
Finally, from the breakdown by production specialisation, it emerges that within the metalworking sector, companies in the machinery and plant sector for industry are the most experts, mainly thanks to improved operating profitability and the lower weight of taxes and financial charges. The case of the automotive sector, on the other hand, seems to be fairly isolated, as it already has low operating profitability, combined with a substantial weight of financial charges and taxes.
Analyses carried out on a sub-sample of companies in the metalworking sector using the reclassified balance sheet data according to the functional criterion, led to some results. These results largely confirm what emerged during the analysis of the sample for which the data in the condensed financial statements were analysed.
Firstly, the balance sheet analysis carried out based on the functional reclassification made it possible to separate the part of capital invested in operating assets from that invested in monetary and ancillary assets. It also allowed to break down items such as current assets and we concluded that most of these are trade receivables.
The analysis of the financial structure also made it possible to provide additional information to those obtained from the aggregated financial statements. The most important information concerns the effective use of debt, which is more limited and equal to about 1/3 of total sources, since part of the debts relate to current liabilities.
Finally, it has been possible to define two important aggregates, namely the trade net working capital and the operating net invested capital. This made it possible to know the resources that companies need in order to carry out, respectively, current management and operational management as a whole.
As far as performance data are concerned, the functional reclassification made it possible to obtain a measure of operating profitability (ROI -Return on Investments-), which for the companies analysed reaches acceptable levels. Moreover, perhaps the most interesting fact is that this profitability is greater than ROE both overall and by breakdown, and this makes it possible to assume that operational management contributes positively to the overall performance of companies.
It would appear that the concerned undertakings do not present operational difficulties, but that the real causes of the low overall profitability, as shown in the previous chapter, can be traced back to the cost of debt and taxation.
The items relating to non-operating actions (e. g. extraordinary income and charges) are not particularly significant.
It was not possible to compare the performance of micro and small enterprises because, due to the selection criterion of the sub-sample, classes 1-5 employees and 6-19 are no longer represented.
Regarding dimensional breakdown, perhaps due to the lower number of cases analysed, the relationship between performance and size seems to have disappeared, even if at a median level the highest ROI values are found in the classes with the lowest number of employees (20-99).
The breakdown by type revealed some interesting differences.
Third-party companies are characterised by a worsening industrial performance, due both to low margins and lower capital efficiency. In addition to this, we must consider a very high and rather expensive debt. The tax burden is also important, although it is not among the largest in comparison with other types.
Finally, the breakdown by production specialisation makes it possible to reach conclusions similar to those of the previous chapter, i.e. that the industrial machinery sector has the best results, followed by agricultural machinery, while the automotive sector seems to face greater difficulties, both in terms of global profitability and, above all, operational.
Results of the analysis
The financial structure of the 211 companies analysed shows a picture in line with that generally observed in many surveys on Italian companies, i.e. low capitalization and significant debt weight (Table 1).
In fact, compared to an average percentage of risk capital (25.3%), the debt figure, largely in the short term, exceeds 70% of total sources. However, the actual use of third party capital is more limited if a distinction is made between current liabilities and financial liabilities in the strict sense (Table 2). This result is evident if we observe the data relating to the sub-sample of 97 companies for which detailed financial statements are available: for these companies, in fact, the exposure to third parties (measured by the median value of financial payables over total sources) reaches 29.3%, while the remaining 23.3% concerns current liabilities.
From the balance sheet analysis, it was also possible to observe that the companies under study achieve a good financial equilibrium. In fact, the value of net working capital (which expresses the difference between short-term assets and liabilities) compared to the total value of the assets is on average approximately 16%, proving that these companies may be able to meet their short-term liabilities through the liquidation of assets within the year.
This balance, however, is largely attributable to the less liquid component of short-term assets (i. e. stocks, semi-finished products and raw materials) as can be seen from the negative value of the treasury margin (-3.8%), which expresses precisely the difference between short-term assets, excluding inventory, and liabilities of the same duration.
As far as economic performance is concerned, the ROE indicator of overall profitability (expressed by the ratio between net profit and equity) assumes an average value of 5.3%, in line with the national level. However, there is a certain dispersion of data around the average; in fact, the standard deviation is 26.7%, a symptom of the fact that the distance between companies in difficulty and those with good profitability is rather high; this is also testified by the fact that the median value (7%) exceeds the average value.
In general, the observed companies achieve good efficiency in the use of capital: the median figure for ROA (which compares the operating result with total lending) is 5.7%. Moreover, ROI, the indicator that best estimates the efficiency of operating management, since it compares the operating result with net invested operating capital, also appears to be at physiological levels (9.8%). The aspect that most seems to penalize the profitability of companies is the weight of financial charges, which absorb 31.2% of the operating result.
Interesting considerations emerged by disaggregating the data, in particular regarding the value of ROE by size class and by production specialization. In the first case, it was observed that profitability decreased as the size of the business increased, except for companies with more than 250 employees (Figure 1). This would seem to indicate that smaller companies perform better than larger ones. This result, consistent with that of ROA, contrasts with the widespread idea that larger sizes are generally accompanied by better levels of efficiency and cost-effectiveness of the company's business. On the other hand, it cannot be ruled out that this is at least partly due to the fact that smaller companies are the ones that usually use debt to a greater extent as a form of financing. In this sense, the higher profitability (in relation to equity capital) would be attributable to the higher level of leverage, which could be a source of weakness in the current economic context, also considering the increase in corporate exposure to banks (Table 3).
As far as companies operating in different sectors are concerned, it emerged that, compared to the "Machinery and Plant for Industry" sector, which achieves the best results, the automotive sector appears to be the one that is experiencing the greatest difficulties (Figure 2), both in terms of margins and overall profitability.
Finally, looking at the companies for which the 2008 data were available, it emerged that in the first year following the outbreak of the crisis, there was a real deterioration in the main indicators in the various areas of management (Table 3). In fact, not only did the profitability decrease (both in terms of ROE and ROI) but there was also a contraction in liquidity, leading to a worsening of the short-term balance.
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This note is taken from Erica Poli's graduation thesis in Analysis, Consultancy and Financial Management, entitled "Economics and Finance in the metalworking sector: an empirical survey on enterprises in the province of Modena", which was discussed on 23rd April 2010. The thesis is part of a research project on the metalworking industry carried out by Metalnet (www.metalnet.unimore.it) under the direction of Prof. Margherita Russo of the University of Modena and Reggio Emilia. We would like to thank the supervisor Dr. Luciana Canovi and Francesco Pattarin of the same University and related to CEFIN - Centro Studi in Banca e Finanza (www.cefin.unimore.it); Monica Baracchi and Daniela Bigarelli of R&I srl for the data of the sample of Metalnet companies.
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