This is a Recovery?

By: Chad Hudson | Wed, Dec 19, 2001
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Economists continue to forecast a “turn” is underway. They all point to the deceleration of the declines in economic indicators. I have to disagree. While, economic indicators are declining slower, they are still declining and there is little evidence pointing to a recovery. In fact, there is mounting evidence indicating further economic weakness. Companies continue to lower guidance for next year along with announcing major lay-offs. The weakness is widespread throughout the economy. “Despite the rise in the leading indicators, there are no clear signs of recovery in the manufacturing sector,” said Jerry Jasinowski, president of the National Association of Manufactures. He also said the general economy will remain in doldrums until the industrial sector begins to catch some wind.

Perhaps the most candid conference call was held by ITT Industries. Here is a portion of the conference call notes as provided by StreetEvents’ StreetBriefs (if you are an institutional investor I highly recommend this new service):

Additionally ITT will be reducing headcount by 3,425. Several other companies continue to announce massive layoffs. Motorola just announced it will fire 9,400 employees and sell four semiconductor plants. GE Capital is cutting 3,000 jobs and will exit some lines of business financing. I also have a hunch that some companies might be waiting until after the holiday season to announce layoffs.

Electronic contract manufacturer, Solectron announced lower than expected earnings yesterday. The PC and telecom markets were singled out as displaying the most weakness. During its conference call Solectron noted capacity utilization was about 50% for the quarter, slightly higher than the previous quarter. Solectron forecasts utilization will increase to 55% in the next quarter. With capacity utilization stagnating at such low levels, the economy is stuck in a catch-22. Economists are forecasting an increase in capital investment will bring the economy out of recession. However, with so much idle capacity, there will have to be a dramatic increase in demand before any new capital investment is required.

Just the opposite is happening. Capital expenditure budgets continue to shrink across all sectors. I remember a guest on CNBC’s America Now last week proclaiming that overcapacity only existed in the telecom sector. I cannot see how he can make such a statement. Besides the ITT call discussed above, Ryder Systems reduced its 2002 capital expenditure plan by $100 million. It is now $100 million lower than 2001, and $700 million lower than 2000. For 2001 Ryder experienced utilization rates of only 60% and is forecasting its tractor utilization to be close to 80% and only 70% for its medium and light duty vehicles.

According to William Stavropoulos, CEO of Dow Chemical, “We really had a capital investment bubble. The overhang is unbelievable.” Throughout the economy industrial capacity utilization is only running at 74.7% of capacity, the lowest since 1983. Additionally, utilization has not “up-ticked” since June 2000 of 82.8.

Just after the close today Steelcase, manufacturer of office furniture, said “in the last few weeks, the company has experienced some softening in orders. Recent conversations with larger customers suggest further tightening of demand. At this time, it is unclear whether this represents something beyond the normal seasonal slowdown we typically experience during our fourth quarter.''

Even “capacity” in the retail sector is greater than demand. OfficeMax and RadioShack both announced they will be closing 40 and 35 stores respectively. The December 10 issue of Business Week contained a very good article discussing the state of retailers (Retail Reckoning, There are just too many stores. Warning: Big shakeout ahead). Most of the article was focused on the dichotomy of retailers between the “category killers” and the victims. There are really only a handful of retailers that continue to outperform. The article singles out Wal-Mart, Target and Kohl’s in the discount area, Best Buy in electronics and Home Depot and Lowe’s in home improvement. Almost all other retailers have been negatively affected by these six companies. Gap was also discussed in detail as the poster child of aggressive expansion. From 1997 to 2000, Gap more than doubled its floor space through a debt financed building spree. Gap went from a net cash position of $17 million in the third quarter of 1997 to a current net debt level of $1.75 billion. Profits and same-store sales a have declined for the past year and a half. The story also references research by U.S. Bancorp Piper Jaffary saying that industry profits have fallen each year since topping in 1996 at almost 4% to a negative 0.17% in 2000.

The holiday shopping season is not helping. TeleCheck Services reported that overall US same-store sales were up only 1.8% for the first 24 days of the shopping season. Even bulletproof Wal-Mart indicated that its sales were below plan; however, that is still around 4% same-store sales growth. There are more than a handful of retailers that would make a pact with the devil for those “disappointing” results.

The U.S. economy continues to weaken. The key question remains what will pull the economy out of recession. Declining corporate spending led the economy into recession, while continued consumer spending has softened the downturn. Since companies continue to announce restructurings, it seems unlikely companies will begin expanding operations anytime soon. Will consumers be able to pull us out? Several economists view the upcoming government stimulus package as the catalyst for consumer to pull the economy out of recession. While final details are still unknown, it is likely to have the same effect as the tax-rebate “stimulus” earlier this year. So far consumers have had about $150 billion made available to them through refinancing and the tax-rebate checks. Not to mention the growth in consumer credit ($59 billion year to August), and retailers and carmakers attempting to stimulate demand. How much more will it take?

I wish everyone a safe and happy holiday.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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