After Economic Storm, Companies Finding a Silver Lining

How Has the Economic Downturn Affected You?

The economic downtown had an adverse effect on each of the client companies surveyed.

• A service-based company reported that business activity declined by about 25% in 2009, year-over-year. The company’s president noted that “the customer pie shrank and creativity with pricing and service offerings became the norm. Almost every existing pricing contract that we had in place from 2008 was subject to customer requested re-negotiation.”
• An apparel manufacturer “had customers cancel orders and re-evaluate their inventory positions” in the fall of 2008. However, in July 2009, orders picked up in response to low inventory positions and the company’s “production levels today are the highest they have been in several years.”
• A professional services firm noted that in late-2008 “long time clients began downsizing their projects.” Further, in early-2009 business was down 14%, but for the full year business was down 12% year-over-year, indicating that the pace of activity in the latter half of 2009 was improving.
• A distributor of chemical products experienced a year-over-year revenue decline of approximately 30% in 2009.
• A building component manufacturer reported that their business has generally tracked the homebuilding industry throughout the economic downturn. While they operated at around 40-50% of capacity in 2009, this level was still ahead of the industry which operated at about 35%. Business activity picked up in the first half of 2010 and the company is operating near 60% of capacity.
• An asset manager stated that “the stock market slide that began at the end of 2007 and accelerated in the fall of 2008 greatly eroded our fee income.”
• A public finance and municipal law attorney indicated that the financial markets collapsed in many respects in the fall of 2008, and demand for his work as bond counsel suffered as a result. However, by the end of 2009, financing prospects had improved substantially, but the deals that were getting done were plain-vanilla, basic financing transactions with virtually no complicating elements. By the spring of 2010, financing lines of credit remained difficult, but was improving. Current financing difficulties are enhanced by the general slowdown in economic activity and the fact that many banks remain undercapitalized, particularly in the face of uncertain regulation (e.g., future capital requirements).
• An electrical contractor, involved in commercial, industrial, and institutional electrical contracting, indicated that “with the economic downturn, the company’s backlog at the end of 2009 was down by about 20% compared to 2008.”
• Several survey respondents indicated that their employee headcount was reduced as a result of the economic downturn. A service-based company stated that they “did not let anyone go or have anything close to a layoff, but those employees that left for further education or spousal relocation, etc. were not replaced.” Similarly, a building component manufacturer said that they “had a few layoffs, but mostly managed to cut the workforce through attrition.”
• A hardware and home improvement products distributor stated that the “housing market downturn has had a negative effect on revenues. Less building means less hardware, lumber, etc… However, it has also made us better managers of the business and has reduced costs by increasing productivity and controlling expenses.”
• One distributor indicated that, as a result of the economic downturn, it had stopped 401k matching and virtually all employees stopped contributing to their retirement savings. Further, overall employee morale was low due to reductions in compensation and benefits in tandem with the prospect of a slow recovery.

What Do You Foresee in the Next 18 Months?

Virtually every company surveyed expects modest growth, but growth nonetheless, over the next 18 months.

• A manufacturer of aluminum extrusion equipment company expects “a recovery of sorts in the U.S.” and reports that their “industry is seeing a pick up in orders.”
• A domestic and international shipping company said they anticipate their business will experience a “gradual, small single digit growth” rate in 2010.
• A shoe manufacturer expects the 2010 fall season “to be better than last year, but there is a sentiment that the economy is still pretty soft and once inventory levels improve and even stagnate a little, we expect 2011 to be flat. 2010 should be a good year, though.”
• One company expects “overall growth for the economy will slowly increase over the next year and a half. Unemployment will remain fairly constant and will take more than the 18 month time frame to get back down to more normal levels. Housing and overall building and building improvements will trend upward with the overall growth of the economy. Consumer spending will increase slightly but will be held back by the unemployment rate and lack of access to credit.”
• A professional services firm expects “slower percentage growth than we experienced historically.”
• A company that distributes sealants and concrete restoration products expects “gradual, but inconsistent improvement” with the inconsistency relating to “some cities recovering faster than others.”
• A brick manufacturer expects “slow, continued improvement over the next 18 months” and they believe “the 3rd quarter of 2011 will be the earliest (their) industry will resume some level of normalcy.”
• An asset manager said that “for the economy, we see very slow growth hampered by high unemployment.”

As indicated by the comments above, most companies are expecting a modest recovery from a micro- and/or macro-economic perspective; however, slow growth rates are anticipated by most companies for the balance of 2010 and into 2011. Survey respondents expect neither a V-shaped recovery, nor a material near-term drop in unemployment.

• Only one client company noted expectations for uneven growth rates across different geographic regions; however, it appears that such region-specific growth rates are relatively common at geographically-diverse companies which are affected by housing markets and/or construction activity.
• A provider of aluminum extrusion systems noted that its business in “China seems to be rebounding nicely with some ordering and quoting activity.”
• One professional services firm stated that they are putting “more focus on existing clients, differentiating (themselves) by exceeding expectations of outcomes.” The firm aims to “grow and retain (a) better percentage of existing clients, understanding that new business is more difficult, more expensive and slower to achieve.”
• In the same vein, an asset-manager indicated that in the wake of a decline in asset prices “clients tend to assume that all (asset) managers are doing as badly as the client’s manager and stay put,” reducing the prospect for obtaining new clients.

Conclusion

A Duke University / CFO Magazine Global Business Outlook Survey asked 1,102 CFOs from a wide range of companies about their economic expectations. In the survey, CFOs of U.S. based companies indicated that 59% of domestic companies do not expect employment to return to pre-recession levels until 2012 or later. Further, one-fourth of domestic companies violated or almost violated a covenant on their credit lines. The top macroeconomic concerns for U.S. businesses are (1) consumer demand and (2) the federal government’s agenda/policies, while the top internal (firm-specific) concern is maintaining profit margins.

Another client provided the following commentary, which summarizes several key aspects of the economic downturn and how companies are operating in its wake:

• “We can hope for “change”, but more likely, we better figure out how to accomplish change. … This recession or economic correction has brought to light a lot of ingredients that proved to be false indicators of true economic growth. … We suspect that most Americans hereafter will buy more cautiously, pursue less credit, and the financial industry will likely go back to asking for more collateral. … As a company, we must remain hungry, competitive and willing to be flexible with the conditions as they change. As we look to our industry, we can see a thinning of the herd has occurred.”
• Yet another client stated that their industry may not return to “some level of normalcy” until the latter half of 2011, but then went on to explain they are not quite sure what “normalcy” will look like. It seems that many companies operating within significantly downsized industries are attempting to understand what the “new normal” will be in the wake of the economic downturn. In the future, normal growth rates in some industries may fall well below historical trends, whereas other industries may soon pick up where they left off prior to the economic downturn.

The economic downturn adversely affected companies in virtually all industries. Shrinking demand in tandem with excess leverage caused many businesses to close their doors. For many surviving companies, the silver lining of such adversity is that management is now better able to efficiently allocate labor and capital, operations are running leaner, employee productivity is generally higher, and market share is there for the taking.

At Mercer Capital, we interact with a large number of client companies operating in many industries. We understand that the economic downturn has not only affected certain industries in unique ways, but also companies within each industry have unique perspectives of the downturn and (cross your fingers) near-term recovery.

What has not changed is the need for sound and reasonable valuation analyses from a trusted advisor. When the need for valuation services arises, please call us at 901.685.2120 to discuss the matter in confidence.