The Crisis in German Construction Affects the Croatian Wood Industry, a Revenue Decline of Up to 40 Percent is Expected

One of the largest crises in the history of German construction has ‘shown its teeth’ to the domestic wood processing industry, concludes the HUP analysis Focus of the Week. Namely, the Housing credit survey (ESB) indicates a similar decline in construction activities as during 2008, and IFO expectations in the construction sector are below levels seen in all crises since the early 1990s. New construction orders in the residential sector accelerated their decline to 37 percent year-on-year in the third quarter, leading to a dramatic drop in imports of everything related to residential construction.

The aforementioned crisis was ’caused’ by a record-fast rise in interest rates (in historical terms) of 450 basis points from the summer of 2022 to today, and smaller companies are increasingly affected by illiquidity due to the prolonged cash conversion cycle.

In the four largest economies (Germany, France, the United Kingdom, Italy), the combined construction/real estate sector accounts for an average of 20-25 percent of all insolvency cases. This points to the collapse of 11,000 construction companies in France, nearly 4,000 in Germany, and 2,000 in Italy.

In terms of affordability for purchasing residential properties, Germany and Austria are among the OECD members with the most unfavorable ratio of property prices to income, making them more exposed to the risks of a stronger decline in property prices. Even after a 10 percent drop from record levels in Germany, the decline in residential property prices does not sufficiently compensate for the decrease in purchasing power, so residential property prices are expected to fall by 15-20 percent in most Western EU markets and by another 5-10 percent in Germany to achieve the desired effect.

In an atypical recession like this, European labor markets are proving resilient largely due to a labor shortage, which, combined with the expected reduction in interest rates in the second half of next year, at least favors the stabilization of demand for real estate, but with slim prospects for a stronger recovery in residential construction activities.

The unfavorable developments in the main export markets (Germany, Austria) threaten to create a strong disruption in the otherwise healthy Croatian wood processing industry, which is the only sector in the manufacturing industry to achieve a surplus in trade (330 million euros in 2022 compared to a ‘positive’ zero in 2013), as highlighted in the analysis signed by HUP’s chief economist Hrvoje Stojić.

What are the trends in the Croatian wood processing industry?

The share of exports in total revenues in this sector is consistently close to 50 percent. To increase the trade surplus in this sector, strong progress in productivity, competitiveness, and many business indicators was required. Although, according to the growth of gross value added per employee from 2013 to today, the Croatian wood industry ranks among the top eight EU members, Croatia remains among the three worst EU members in terms of productivity at the same criterion, which increases vulnerability to exogenous shocks.

Total revenue, or exports of the wood industry, doubled from 2018 to 2022 to 2.1 billion euros, or 980 million euros. At the same time, the Croatian wood processing industry increased its operating profit (EBITDA) by about 2.7 times to 335 million euros in 2022, and the EBITDA margin nearly doubled to 15.9 percent compared to 2019.

Finally, this sector has significantly reduced its indebtedness as seen through the decline in the net debt to EBITDA ratio from a maximum of 2.80x in 2018 to just 0.40x in 2022. Recently, however, a sharp deterioration in conditions in the main markets has caused a 26.9 percent drop in exports of the Croatian wood industry from June to August of this year, and in line with the worsening business climate in German construction, we expect even worse export results in the short term.

In a recent survey of members of the HUP association of the wood and paper industry, as many as two-thirds of companies expect a revenue decline of up to 40 percent in 2023, and over 60 percent expect a revenue decline in the first half of 2024 in accordance with the behavior of foreign partners. It is significant that even 57 percent of respondents cannot predict a turnaround in negative trends or reliably plan due to uncertainties regarding energy prices, input materials, rising inflation, and regulatory uncertainties.

Therefore, as many as 61 percent of companies expect that in the upcoming production cycle they will not be able to utilize available raw materials. Despite fears that in the event of layoffs they will no longer be able to find quality domestic employees, one-third of companies have already reduced their workforce by five to 20 percent. HUP therefore supports the adoption of measures that will temporarily co-finance the retention of jobs in the industry, which before this unprecedented crisis continuously improved its business fundamentals and plays a significant role on the supply side of the Croatian economy, states the analysis.