Growth continues but some turbulence ahead

It has been four years since Central Europe’s largest economies joined the European Union. Two more Central European countries became members in 2007 and the remaining states are in the queue. The economies of the ‘New Europe’, which were once behind the ‘Iron Curtain’, are integrating dynamically with the ‘Old Europe’ and gradually preparing to convert their currencies to the euro. What is even more noteworthy, they have become motors of growth in the EU, especially during the recent crisis in financial markets and the slow down in the euro zone.

How are these countries coping with the new political and economic realities, how are the various industries in the region developing and what are the challenges facing investors and managers of the leading Central European companies, banks and insurers? A comparison of the financial situation of the 500 largest companies and financial institutions in Central Europe is one of the tools for assessing trends in the region and the state of its economy. This year, we are focusing on the growth strategies the biggest companies in the region are following, how they are coping with the rising input costs, the appreciation of local currencies and the ever more scarce and costly labour force, which, not so long ago, was a resource significantly cheaper and more accessible than in Western Europe.

As in 2006, most Central European companies reported dynamic growth. Average revenue in local currency grew by12 per cent and in euros by 15 per cent. This was a high rate compared to Western Europe. It seems that the region has been only minimally affected by the economic slowdown, despite the fact that the average revenue growth of the CE Top 500 companies remained at the same level for the last two years and their average ROE and ROA fell imperceptibly.

The main companies increased their revenues mainly through acquisitions (PKN, CEZ) or through reorganisations and consolidations (PGE, Tauron). However, those companies, which did not increase the scale of their activities through M&A, also reported double digit revenue increases.The total dynamic growth of the 500 largest companies in the region comes only partly from the firms at the top of the list. Despite the fact that the revenues of the ten largest firms grew by nearly 15 per cent in 2007 and 25 per cent in 2006 –similarly to the combined GDP growth for the region, a large part of this increase should be attributed to foreign expansion or consolidation. However, if we look at the first 100 companies on the list, we see that they reported an average 12 per cent revenue growth while the last 100 enterprises grew by nearly 20 per cent.

The largest percentage growth of revenues in 2007 came from companies in the Baltic countries and Serbia. Enterprises fromcountries which were the first to join the EU - Poland, the Czech Republic, Hungary and Slovakia - saw revenue growth of 17 per cent, 10 per cent, 13 per cent and 15 per cent respectively. These increases are to a great extent linked to the sectoral structure in each country. Both consumer products and industrial products sectors reported high growth rates of 18 per cent and 20 per cent. The revenues from the enterprises in the remaining sectors grew by little more than a half of these rates.

This significant presence of the Polish companies on the CE Top 500 list results from a combination of several factors including: regional acquisitions (PKN, Ciech), consolidation of the energy companies (PKE, Tauron, Enea) and the dynamic growth (18 per cent compared to 2006) of locally based consumer product and distribution companies (Metro, Jeronimo Martins, Carrefour, Tesco) and manufacturers such as FIAT, Saint – Gobain, Mittal Steel. Similarly to Polish companies, the largest Slovak and Ukrainian enterprises have increased their share in the total revenue of the largest Central European firms.

Polish companies dominate the ranking with 176 companies in the list. The combined revenue of these companies accounted for 34.3 per cent of the total 500 companies, which is not surprising given the size of the Polish economy in comparison to other economies of the region.

The positive impact and significance of greenfield investments, especially in the automotive sector, have been particularly noticeable in Slovakia. Slovakia’s largest companies increased their share in the total revenue of the largest Central European companies by almost 100 basis points from 5 per cent to 6 per cent as a result of the opening of KIA Motors and Peugeot Citroen plants.

While most of the new EU members have benefited from the foreign direct investments, Ukraine-based companies have grown primarily as a result of mounting demand for heavy metals and energy. Ukraine’s largest companies operate, above all, in heavy manufacturing and energy sectors.

The combined revenue of Czech and Hungarian companies accounted for 15 per cent and 14.5 per cent of total revenue of the CE`Top 500 companies. The revenue of the largest companies from these two countries is higher than the GDP share of the Czech Republic and Hungary. This confirms the strong position of these entities in the Central European market place. Despite high growth achieved by single companies (CEZ, Skoda, Audi Hungaria) and new greenfield investments (Toyota Peugeot in the Czech Republic, Philips Hungary, Suzuki Hungary), their share decreased slightly compared to companies ranked in 2006. The Czech Republic and Hungary have only to a limited extent benefited either from the consolidation in the energy and raw materials sectors or the increases in oil prices. On the other hand, Hungary stands out in terms of the number of large TMT companies including Nokia, Hungarian Telekom Samsung and Flextronics.

The latter recorded a fall in revenue in the fiscal year ending on 31 March 2007, however, based on the information from the company, the decreasing revenue trend was halted in the fiscal year ending on 31 March 2008.

Following the consolidation of the Lithuanian Mazeikiu oil combine purchased in 2006, PKN has strengthened its position at the head of the CE Top 500 ranking. The group has been the largest company by reported consolidated revenue for years and with its financial results consolidated with Mazeikiu, its revenues are more than 60 per cent higher than those of MOL, which follows PKN Orlen in the ranking.By comparison, the difference in revenues between these two companies in 2006 and 2005 was only 24 per cent and 3 per cent respectively.Skoda Auto has been expanding its production capacity for several years. In 2007 the revenue of this manufacturer of popular cars selling to the east and west of Mlada Boleslav rose by 11 per cent. The company’s factories are located not only in Central Europe (Slovakia, Bosnia and Herzegovina and also Ukraine) but also in China, India, Kazakhstan and Russia. Skoda is owned by Volkswagen, the largest foreign investor in CE and is the enterprise whose subsidiaries inCentral Europe have the highest total revenue (i.e., estimated revenue of Volkswagen controlled entities) in the region. Like Skoda, another Czech firm - CEZ - is implementing a foreign expansion strategy, although this is not always based on building new plants but also through takeovers of power generators in other countries of the region (Poland, Bosnia and Herzegovina and Serbia).

The automotive sector is well represented in the CE Top 500 ranking with 50 firms on the list. Total revenues of these companies reached EUR 38 billion in 2005 and around EUR 60 billion in 2007. This is primarily the effect of major modernisation and expansion of existing plants and moving production from Western to Central Europe and especially to the Czech Republic and Slovakia. The group of 50 automotive companies contains five leading car manufacturers, which have moved production to these two countries. The CE Top 500 list shows the effect of these moves. For example the fact that two companies, Kia Motors and PCA Slovakia, came on stream in 2007, increased the revenues of this sector by nearly EUR 2.7 billion and employment by 5,700 people. The growth rate recorded by car producers in Hungary, Ukraine, Romania or Poland (where FIAT is present), exceeded 20 per cent, however, as mentioned above, Volkswagen leads the way, well ahead of other manufacturers.

Steel is another significant sector in the region, which has been confirmed by the results of the CE Top 500 ranking. Production of steel and ferrous and non-ferrous metals has for several years generated over 8 per cent of the total revenues of the CE Top 500 list. In 2007 alone, this sector’s revenues rose by over 14 per cent as a result of acquisitions made byMittal Steel, US Steel and others.

The consumer goods sector, which is relatively well represented in the CE Top 500 list (in total 133 out of 500 companies, with almost half of them based in Poland), saw its joint revenues grow by 22 per cent in 2007, although its share of the total revenue of the CE Top 500 stayed at the same level as in the previous year. Also, food and beverages sub-sector was the source of an almost 70 per cent increase in revenues.

PKO BP has lost its number one position as the largest Polish bank by assets to Pekao S.A. (the second largest on the list of Central European banks), which has finalised its merger with BPH S.A. It is worth noting that PKO BP is one of the few banks on the list which are still state-owned. Indeed, there are a mere five state-owned banks in the top fifty banks. In contrast to the majority of banks on the list, the two largest Czech banks – CSOB and Ceska Sporitelna (first and fourth place, respectively) are not listed on the stock exchange. Also, the ranking shows that the largest Polish banks are less efficient than, say, Czech banks. In the case of PKO BP the amount of assets per employee is as low as EUR 0,99 million and EUR 1.5 million in the case of Pekao S.A., while for CSOB and Ceska Sporitelna these numbers are EUR 4.2 million and EUR 3 million, respectively.

There are 120 companies on the CE Top 500, in which the state holds a controlling share with 48 from Poland. The revenues of state-owned companies amounted to nearly 20 per cent of total revenues of the companies on the list and despite the fact that privatisation policies are being actively pursued, this share is not falling. This can be primarily attributed to the failed privatisation of energy and infrastructure companies, which are granted special status in many former socialist bloc countries. This can be seen very clearly in Poland, where the state treasury has been trying to either privatise its ‘crown jewels’ through public offers, which enable it to retain control or simply leave certain companies on the privatisation ‘shelf’.However, foreign investors are widely present in the region and FDI continues to flow to Central Europe. The operations of some of those investors are so significant that they dominate the Top 500 list. Volkswagen, Arcelor Mittal, retail chains and telecom giants are well represented in the region,not to mention financial institutions such as Erste or Unicredit Bank. Not only the revenues generated in Central Europe make them the leaders of the ranking, but more importantly, those revenues continues to grow at double digit rates with only a few companies recording flat or slightly decreasing growth. Foreign companies have mostly invested in automotive and metal processing industries, followed by telecommunications and the consumer goods sector, where the presence of large western distribution networks is clearly visible.