Gain Some Perspective
Status of the Recovery and Future Outlook
by Michael Collins
Having survived a period when a tough recession had the
potential to lapse into an outright depression, it is worthwhile to examine
the current state of the door and window industry. There are three key
areas that must be considered: financial and economic conditions, the
state of company operations and the outlook for pace of recovery.
While companies generally have paid down debt over the last two years,
debt levels among door and window manufacturers are still too high. In
some cases, this causes a financial dilemma known as “debt overhang.”
This occurs when a company is not able to obtain additional funding, even
for a compelling opportunity, because the size of the existing debt makes
it unlikely that new debt or equity will ever receive a return on capital.
In such cases, if the company isn’t able to pay down its debt through
other means, it is likely that any sustained downturn will push the company
into bankruptcy. One of the downsides to recovery is that, as sales increase,
companies must fund additional working capital needs.
In most industries, and in most normal economic periods, companies needing
additional working capital because sales are increasing strongly can count
on numerous lenders competing to win their business. Many traditional
bank lenders, though, are tightening their purse strings with respect
to companies in the building products industry. Some manufacturers with
whom we are in touch have drawn their lines of credit up to the limit,
placing the excess funds in another financial institution. This strategy
has come as a response to stories about companies that paid down their
lines, only to have their limits reduced to their new lower balances.
Manufacturers respond to this stance on the part of lenders by seeking
out those still willing to lend to building products companies or by taking
advantage of alternative forms of capital, such as mezzanine debt or equity.
The door and window industry continues to suffer from having too many
plants and too much equipment available. Fortunately, the rate of plant
shutdowns has slowed sharply from 2008 to 2009, allowing asset auctions
to catch up and reduce the supply of equipment. There remains, no doubt,
an inventory of excess equipment to be auctioned, but the majority of
this will likely be worked through by the middle of next year. As with
merger and acquisition transactions, companies acquiring equipment typically
are doing so in advance of any actual need for the production capacity
represented by the equipment.
Pace of the Recovery
There is a great deal of discussion lately regarding what “shape” the
recovery will take. This debate centers on whether the recovery will be
V-shaped (a strong, sharp recovery) or U-shaped (a longer, slower recovery).
An increasingly popular point of view is that the recovery will be W-shaped.
This would indicate a downturn followed by a brief period of recovery
that gives way to another brief downturn. Only after all the negative
factors lingering during that second downturn have dissipated does the
long-term recovery finally take hold. We are seeing some evidence of that
trend right now. Some of the housing data lately has been markedly positive,
but home foreclosures are still rising. In a W-shaped recovery, the pick-up
that a number of companies are seeing because it is summer and because
of the .30/.30 tax credit would be offset by continued home foreclosures
driven by mortgage rate adjustments and job losses.
Fortunately, in a W-shaped recovery, by the time it is generally known
that the recovery will not be a smooth upward line, the final leg of the
recovery is starting to take hold. At our current crossroads, there are
a number of factors that will help return the industry to some semblance
of its former growth path: the economic recovery, permanently high energy
prices creating a market for energy-efficient products, continued immigration,
new household creation and several years of underinvestment in homes and
businesses. We believe that all of these factors will act against the
existing negatives, so that by the middle of 2010, the start of a broad
recovery will occur. y
Michael Collins is vice president of the building
products group at Jordan, Knauff & Company, an investment banking
firm that specializes in the door and window industry. He may be reached
Mr. Collins’ opinions are solely his own and do not necessarily reflect
the views of this magazine.
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