The phrase “the perfect storm” has often been used to describe events that have come together in a most unexpected and devastating way. The effects of the simultaneous occurrences are far more powerful than if they had occurred independently.
In our August newsletter we raised concerns about the anticipated fallout from the credit crisis in global markets. The article provided a few key warning signs that companies should be aware of as the uncertainty in the economy grows stronger.
Additional recent events in the world financial and commodity markets have now led some to believe that we are heading for a ‘perfect storm’. What are the triggers? And what are the likely impacts on the Australian economy?
First though some recent headlines from the major newswires:
“Greenspan 50/50 on Recession” – Reuters 08/10/07
“Crisis was “accident waiting to happen" Greenspan” – Reuters 21/10/07
“Bernanke: Housing Woes to Slow Growth” - yahoo 15/10/07
“Credit turmoil could mean turning point for growth” – Reuters 22/10/07
“U S Home Foreclosures Double” – Foreclosures Daily 17/10/07
“Greenspan Says `State of Fear' in Credit Markets” - Bloomberg 23/10/07
“173 US mortgage companies have imploded in the past 12 months” – The Mortgage Lender 23/10/07
“Alarm bells ring ahead of CPI release” - AFR 23/10/07
“Banks warn on higher loan rates” - AFR 23/10/07
US credit crisis
The housing and credit crisis in the US has greatly impacted world credit markets causing a dramatic reduction in liquidity. The market has improved slightly but we are now seeing higher pricing of risk across the board and a re-rating of risk by the major credit agencies. The net result is that debt is becoming harder to source and more expensive for existing and prospective borrowers.
The effects of this are starting to be felt locally, as we are already seeing the emergence of tighter credit policy and higher pricing. This will impact negatively on those businesses that operate on high volume, low margin models and those businesses that are already highly exposed to debt.
The US real estate crash is still unwinding with similar concerns now being expressed about the UK market. As a high proportion of small to medium business owners in Australia have used their properties to finance their businesses, any reduction in Australian property prices will have a dramatic effect on their ability to raise additional finance which will slow their growth or lead many to experience a cash flow crisis.
Oil price
Oil has increased by approx. 50% this year to a high of US$87 of late prompting some analysts to speculate that a price of $100 is now possible. The upward pressure is due to a number of factors including the continuing unrest in the Middle East, increasing demand from China and India, a weak US dollar and an all time low in excess production capacity.
The issue of real concern for Australia’s debt laden families and small to medium businesses is that every 12% increase in oil is equivalent to a .25% increase in interest rates. Therefore, we have actually had 6 interest rate increases this year (2 normal plus 4 equivalent).
High cost of labour
The latest figures released on Friday show that Australia now has the lowest unemployment levels in 33 years at 4.2%. This has further strengthened the belief that interest rates will be increased again towards the end of this year and into next year.
Employers currently find their business activities constrained by a lack of available and skilled staff and the additional high costs of luring new staff or even keeping their own staff in the business. This problem is unlikely to go away even if there is a slowdown in economic activity. These issues are proving both disruptive and costly for most small to medium businesses as they struggle to perform in volatile labour markets.
Interest rate rises
The Reserve Bank has an often stated policy of keeping inflation within 2 – 3 % per annum. Recent events are testing the limits of this policy and therefore require the RBA to use the interest rates to curtail this. The effects of a buoyant economy, low unemployment, growth in real wages, increased food prices (because of the drought) and increased fuel prices all lead to the need for the Reserve Bank to raise interest rates further to keep the lid on an overheating economy.
Given the record levels of individual and small business debt, an increase in interest rates will result in a reduction in discretionary spending and slow economic growth.
High Australian Dollar
In recent years and in particular over the past few months, the strong economy and interest rate differentials between its major trading partners and Australia has placed upward pressure on the currency. The currency is currently trading at around 90 cents with some analysts anticipating it going as high as 92.5 cents by the end of this year and 95 cents by mid 2008.
This is having a significant impact on non mining related exporters. For those companies relying heavily on exports they may be finding it difficult to remain competitive so either margins or sale volumes will come under pressure.
The high Aussie dollar is great news for importers though who find their goods being very well priced and an opportunity for greater profits. The concern is that too much of this sector is towards the non essential or luxury market. The Reserve Bank finds itself having to consider the long term effects of raising or leaving current interest rates as they are. Any increase in rates will lead to more inflows from foreign buyers of the dollar and will lead further upward pressure of the currency.
Faced with so many divergent pressures, business owners need to be thinking very strategically in the coming months to ensure that their business can weather any upcoming economic downturn.
For more information please feel free to contact one of the team at Vantage Performance.
Regards
Michael Fingland
Managing Director
Vantage Performance
Turnaround Management Specialists
26 October 2007
The Perfect Storm?
11 October 2007
New Vantage Performance Podcast
Michael Fingland, Managing Director of Vantage Performance, has launched our latest podcast edition. This podcast is exploring the complex and highly specialized world of corporate turnarounds.
This new podcast discusses the causes of decline and distress on a business particularly the external factors that a business can face.
For more insights, check our podcast link or download it at Itunes.
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See you next time.
Vantage Performance
Turnaround Management Specialist
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Vantage Performance
Turnaround Management Specialists
09 October 2007
Job Advertisements down by 5% to 11% in September
Australian Job Advertisements declined substantially in the month of September 2007
- Banking jobs fell by 11%
- Finance jobs fell by 5%
- Investment banking and corporate finance fell by 9%
- Accounting jobs fell by 4%
This is a reversal of recent trends and may be the result of negative sentiment creeping into the market as a result of the US credit crunch.
Vantage Performance
Turnaround Management Specialist
02 October 2007
Warning Signs Of A Company In Trouble
When considering an acquisition of, investment in, or employment with a company it is best for your peace of mind, as well as, financially to be aware of indications that the company’s true picture may not be what management would lead you to believe.
The surest sign that something is amiss is a frustrated stakeholder – be it the owner, investors, or lenders. What are their concerns? Have there been repetitive problems with the company? Does management not seem to have the right skill set to handle the most pressing issues? Does management spend too much time assessing blame and not a lot of time accurately identifying the company’s problems and devising solutions?
Where to Start
It is best to first take a look at the company’s financials. Start with the balance sheet. Are they building inventory and not able to sell it? Do they have a negative cash position? Have they maxed out their borrowing base? Also be sure that the balance sheet reflects the true state of affairs. For example, has the company written a check which it has yet to mail despite debiting its accounts payable account?
Take a look at the income statement, preferably one with monthly performance over the last 12 months. Group the items into three categories: sales, variable costs including direct sales costs, and fixed costs. What trends do you see in those categories? Perform a breakeven analysis. What is their contribution margin? Is it declining? What about EBIT? Is the company able to service its debt?
It can be helpful to simplify a company’s financial statements, combining similar items in order to move out of the detail and focus on the company’s overall performance and financial position.
The greatest mistake is not necessarily investing in a troubled company, but rather misdiagnosing the company’s problem(s).
Checklist
Here are some items to consider when performing diligence on a company:
Cash shortfall – does the company seem to be constantly in a cash crunch?
Physical deterioration of facilities – signs of inability to maintain facilities due to lack of proper planning and ability to re-invest.
High concentration of leased assets – inability to secure traditional financing.
Lender blamed for current condition – indicates a lack of willingness on management’s part to accept responsibility and look for solutions.
Mounting external pressure – litigation, displeased vendors and creditors, and troublesome audits.
Poor external/internal communication – the lack of effective communication with external parties such as lenders and vendors, as well as, internally with employees can indicate the presence of negative information suppressed by management.
Critical information ignored or discontinued – management is not focused on how the company generates earnings, instead preferring to ignore it and replacing it with less valuable indicators.
Defensive management team – a management team that is always putting out fires is less likely to be able to proactively plan to grow the company’s business.
Liabilities ignored or underreported – the creation of financial statements which do not accurately reflect the company’s true performance and financial position can lead to much more aggressive actions than would be warranted, thus exacerbating a company’s problems.
Credibility problems with key constituents – the inability for management to be trusted can create unnecessary hurdles for management.
Dishonest/Unethical business practices – this indicates a willingness to push the envelope in the face of mounting negative business pressures.
Ownership distracted by outside activities – this can indicate a lack of time for necessary oversight over management.
Deny accuracy of negative information – management is unable to accept reality and deal with it accordingly, instead preferring to “shoot the messenger”.
Looking for a “home run” to fix everything – a management team counting on the next product line, next store, or next IT system implementation to solve its troubles is likely to not be focused on tackling the true problems facing the company.
Inventory is over weighted in slow moving items – this can indicate a lack of unwillingness to write-down assets and accept reality.
Quality issues with products and services – an indicator of poor management and future loss of sales.
Market share losses – this can indicate an inability of management to compete in the marketplace and presages future financial pressures.
Backlog declining – the company faces the potential of declining future sales and EBITDA.
Departure of key employees – May indicate an inability to pay talent their market rate or otherwise maintain an attractive work environment. Also may indicate that key employees realize the company is in trouble.
Unmotivated/depressed employees – the general attitude of lower level management and employees on the shop is a good gauge of how things are going at the company. Oftentimes they are able to catch on to a company’s troubles before it reaches the executive suite.
Conclusion
It is important to note that a troubled company often exhibits some combination of the factors described above.
When examining a company, be sure to be on the look out for these potential warning signs. As always, seek first to have an accurate and meaningful set of financial statements to guide you.
If you would like to discuss this topic in more detail please feel free to contact us.
Regards,
Michael Fingland
Managing Director
M +61 407 226 968
T +61 7 3229 5750
F +61 7 3229 5765
Level 5, 247 Adelaide StreetBrisbane QLD 4000
mfingland@vantageperformance.com.au
http://www.vantageperformance.com.au/
Listen to Turnaround Insights Podcast
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Vantage Performance
Turnaround Management Specialists
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