LOOKING AHEAD - 2011

Recommendations for critical strategic problems and opportunities
facing the electrical apparatus service Industry in 2011 and beyond.
by: Pete Smith
C&S Associates, Birmingham, Alabama

"Over thirty years advising business owners
in the electrical apparatus service industry"


Pete Smith


Introduction

Happy New Year! May 2011 be a healthy and prosperous year for you and your family.

In previous issues of “Looking Ahead,” we have addressed operational and financing issues: hoarding cash, training, labor productivity, customer E-communications, diversification, industry consolidation, etc.

While these issues are still relevant, this issue of “Looking Ahead” addresses economic trends and how these might be used to improve your sales, number of active customers and your bottom line.

Four Year Perspective

For many electrical apparatus service companies, 2008 was a record positive year, 2009 a record negative year (at least since 2004), and 2010 a year of recovery. Not only were sales off across the board in 2009, but most businesses lost at least one or two of their top customers. The trend to move manufacturing offshore continued; however, the greater problem was that the cash flow of many businesses was unable to withstand the almost shut-down of the banking system after the collapse of the Lehmann Brothers in September of 2008.

Most economic indicators point to a 2011 better than 2010, at least for top line sales. As usual, this assumes no major geopolitical changes: wars, major acts of terrorism, etc. Whether that sales increase will translate to improved bottom line profits is up to you!

Good News / Bad News

J Demand for raw materials and certain manufactured products will increase with the continued growth of developing nations, specifically China. US companies that export products have benefitted and will continue to benefit from this growth. The Vice-Chairman of General Electric is relocating to Hong Kong.

J Food and energy demands will continue to increase in both the US and worldwide. Prices for coffee, sugar, and other food commodities are up from 30% to 60% in 2010. Starbucks has raised prices on most coffee products. Coal and oil prices are headed north again; the average pump price is now over $3.00 a gallon for regular gas. Investment in wind and alternative energy sources remains high in spite of the higher cost per kilowatt hour than conventional energy.

JThe results of the November elections and the recent legislation to continue the Bush tax cuts and to provide incentives for business investment are the first bright spots for business under this administration.

L Inflation is coming; inflation is coming; inflation is coming! The abuse of the government debt both in the US and abroad is catching up at the federal, state, and local levels. By any “business” financial measures, the US government, many foreign governments, most of the 50 states and hundreds of local governments are bankrupt. Greece, Portugal, Spain have already aired their financial crises. The European Union is inherently unstable. The Chinese have recently raised their government interest rate to slow down their nation’s inflation – a very surprising move! The trickle-down effect of these macro-economic crises will impact every business including yours!

L The price increases in almost all commodities, including copper, are the result of both increased real demand and some speculation by commodity traders. Either way, they are the seeds of inflation as these commodities are turned into products and sold. Increased prices to the end user are needed to maintain margins, but hard to obtain from the customer especially for service businesses.

L Residential and commercial real estate development will remain low. There is still a surplus of real estate available from foreclosures and desperate owners. Lower prices are stymying any significant construction. A local company near my home rents out construction trailers; another company rents out construction cranes. Both of these companies have product in their storage yards piled as high as I have seen in thirty years.

L The new health care legislation and certain senseless provisions within it, such as requiring 1099 forms for every vendor, will cost you more money. Increased taxes, fees, and regulations dreamed up by government employees (at all levels) who have never had to meet a payroll are unavoidable. At least the new Congress in 2011 may be able to slow down some of these increases at the federal level.

J L Job recovery will be slow. Ninety-nine (99) weeks of unemployment benefits is a license to take a two year vacation at the expense of business owners who foot the bill for unemployment insurance. (Many of these “unemployed” also moonlight in the underground economy and are paid in cash!) The upside is that as these benefits finally run out, there may be a better pool of unemployed talent from which to hire new employees. I have visited a number of shops in the latter part of 2010 that are understaffed, have work on the floor to be done, but are not hiring new full time employees because of the lack of good talent available and the, still to be determined, costs of the new health care package.

J L The banks have money to lend. The credit and paper work requirements to receive these loans are becoming more onerous. The SBA now requires certified appraisals on business loans over certain limits. Collateral requirements are becoming more stringent.

J L Business buying and selling activity has increased. Global merger and acquisition activity is up 18% in 2010. Public companies have the cash available to make acquisitions, and private equity groups are activity seeking new acquisitions. Generally, these are bigger deals than individual companies in this industry. However, in the past six months, I have seen some of the trickle-down effect into this industry as select companies are looking to make acquisitions.

The core problem is that the selling companies have a jagged track record of profits and cash flow from the up, down, up results of 2008-2010. Potential buyers don’t know how to predict the future and are generally pessimistic in their financial projections. Potential sellers are overly optimistic in their projections, seeing 2009 as an anomaly rather than part of the overall economic cycle that is inherent in this industry. Some of us remember the economic down cycles in the early 1980’s, again in the mid-1990’s and then in the 2003-2004 time frame.

Recommendations

Customers: Look for potential customers that are exporting. Find out from your local Chamber of Commerce or other business association which companies in your area are exporting. While the US economy is predicted to improve, the real action will remain overseas.

In the past I have recommended going after infrastructure business: water works in particular. Many of your municipalities are broke. Prices will be negotiated to the bone and getting paid will be a hassle. Be careful!

Look for new customers in the food, energy and commodity industry. These include suppliers and companies supporting those industries. Be careful with customers in or serving the new construction industry. The silver lining in the construction doldrums is those companies that produce for or serve that aftermarket. Repairs and energy efficiency improvements of current residential and commercial real estate will increase as these structures age.

Personally, I think natural gas will be the preferred source of energy in a decade or so with nuclear being the long term answer over the next century. Natural gas is cleaner and more efficient than most other fossil fuels; less capital expenditures are needed to deliver the product to the end user. The US has huge reserves underground. However, demand and the price of natural gas remain low. Political and popular attentions remain on other alternative energy sources.

Pricing: Work hard to increase prices every day. If you are not getting a pricing complaint from at least one in ten to twenty jobs, you are probably leaving money on the table. Make your quotes subject to changes in copper prices. Copper has increased around 30% in the last 90 days and is still climbing! If you are not aggressive on pricing, inflation and increased commodity prices will freeze or decrease your real dollar bottom line.

Health Care: If you are providing 100% of the family or even 100% of the employee’s cost for health coverage, re-look at that policy. There will also be some “quick fix” programs that some new or very small insurance companies or other companies looking for a fast buck will dream up to “help” business owners keep their cost down in light of the new health care legislation. Be very careful if someone offers you a new health insurance package that seems too good to be true – remember Bernie Madoff.

I don’t know how the final legislation will treat the deductibles. I’m no expert; I admit I haven’t read the 2000 pages in the bill. Investigate the possibility of increasing the deductibles and sharing that cost directly with your employees. It may cut down on the trips to the doctor for a runny nose.

Loans: If you have any variable rate loans, convert them, or at least a part of them, to a fixed rate, even if it costs you four, five or more points. Many of you maintain a line of credit that never reaches zero. At one time lines of credit were supposed to be at zero at least once a year. Their purpose then was to cover financing needs for annual cyclical or seasonal trends related to particular industries.

Today, many companies rely on their lines of credit to operate. The balances never go to zero; the interest is variable, and the note is callable by the bank in 90 days. Your banker has no reservations and all the power needed to increase your variable rate as the bank’s cost of funds increases.

Buying / Selling

Deal activity within this industry was very slow in 2009 with some improvement in 2010. For a few months the number of listings of Business for Sale in Electrical Apparatus could be counted on one hand with fingers left over. That count has started to increase.

Business appraisal has never faced a tougher set of problems than today. Business valuation is a prophecy of the future. While history is usually the best indicator of the future, there are so many “unknowns” that make the future speculative and history unreliable: economic, geopolitical, energy, etc.

As I mentioned before, the differential in price between buyer and seller is much greater now than after a run of three, four, or more years of consecutively increasing sales and profit years.

My business focus has shifted more toward business advisory services:

  • Business appraisal for selling, buying, estate, gifting, divorce, stock buyouts,
  • Business appraisal reviews for assessing credibility of business appraisals,
  • Preparing a business for sale or ownership transition: preferably with a two or three year lead time to polish the business for maximum value,
  • Assisting sellers or buyers through the entire buy/sell transaction process,
  • Assisting owners in strategic planning, inter-generational transfers and bank financing.

Call me in confidence to discuss any of these services. There is no cost or obligation for an initial phone consultation. I have enjoyed working with business owners in this industry for the past thirty years and look forward to the next decade.

For online copies of the “Looking Ahead” newsletters, visit the following links.

 

http://www.value-a-business.com/EAS/LookingAhead2007.shtml

http://www.value-a-business.com/EAS/LookingAhead2008.shtml

http://www.value-a-business.com/EAS/LookingAhead2009.shtml includes 2010

http://www.value-a-business.com/EAS/LookingAhead2011.shtml this issue

Thank you.

petesmithsig1.jpg

Pete Smith

Member of the Institute of Business Appraisers

Accredited in Business Appraisal Review (ABAR)

petesmith@value-a-business.com

http://www.value-a-business.com

Office: (205) 987-5315, Cell: (205) 837-4845