Volume 9, Issue 6 - June 2008

trend tracker

Beware of the Recovery
Make Sure Your Balance Sheet is in Order 
by Michael Collins

Most participants in the door and window industry, including manufacturers, distributors and component suppliers, have been struggling to varying degrees for the last two years. In recent months, new and existing home sales have sometimes sent conflicting signals and the builder confidence index has held steady in the face of continued negative housing numbers. In short, there has been so much negative news that we’ve become numb to it. It is at such times that markets begin their recovery after a long, slow decline. Anecdotally, we have already begun to hear from door and window manufacturers that their business is picking up somewhat. Later in the year, we may see a publicly traded builder beat (admittedly low) earnings expectations and the housing numbers come in better than expected, moving consensus toward a recovery scenario. We may need to ask for an extension to the beginning of 2009 on that prediction, but the point is that we’re much closer to the recovery than we are to the start of the decline.

If you agree with that, you may wonder why we should beware the recovery. Simply put, a period of growth can be a very difficult period, particularly for companies whose balance sheets are not in an optimal condition. There are several types of companies that will find the coming recovery period to be very difficult to navigate. Among these are door and window distributors that have endured a tightening of credit terms from the manufacturers that supply them. Maybe these distributors were affected by the failure of large builder or contractor customers or perhaps they found themselves making payments late. It also is likely these distributors were unable to share the pain of tightening terms by passing accelerated payment requests along to their customers. In any case, a recovery period will exacerbate this problem when these distributors receive an influx of orders for which they will be paid more slowly than they are required to pay for products themselves. The investment of capital required to satisfy this differential could be significant. Door and window manufacturers that are willing to dig into the situation and work with distributors facing these difficulties will likely find that relaxed terms will give them an opportunity to win these challenged distributors as customers.

Other companies that may struggle are relatively newly formed ones. Such companies are typically founded with the minimum possible capital and may not have the balance sheet flexibility to take full advantage of an upswing in the market. For newly formed companies, periods of growth can be just as challenging as periods of stagnation. In addition to financial constraints, periods of growth put stress on systems that may operate well in a slow period but not during a growth spurt. It would be a shame for a new company to make it through this difficult market and then fail to ride the wave of recovery because of capital issues. On the flip side, even a well-established manufacturer facing a better capitalized competitor may find that competitor is able to win an outsize share of new business in a recovery by offering more attractive terms. Being able to offer customers better terms lets them effectively “borrow” the strength of the manufacturer supplying products to them. Distributors, retailers and wholesalers always will gravitate toward companies that make it easier for them to do business. 

A well-established company with inadequate capital may find itself unable to benefit fully from the recovery period that lies ahead. This means that they will leave some money on the table in a recovery. For a newly established or highly troubled company, though, the consequences could be much more severe. We would advise all companies, while the market is still soft, to conduct a lifeboat drill regarding the strength of their balance sheets. To the extent that companies find they would not be able to participate fully in a long-awaited and much deserved recovery, it behooves them to take steps now to improve the strength of their balance sheets, possibly seeking additional sources of capital. 

Michael Collins is vice president of the building products group at Jordan, Knauff & Company. He may be reached at mcollins@jordanknauff.com. Mr. Collins’ opinions are solely his own and do not necessarily reflect the views of this magazine.


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