For those of you who have taken any of my banking courses you will recognize the core cash drivers that every firm has that I discuss in depth. These core cash drivers are areas where cash either pools up for a firm causing a cash shortfall or is an area that owners can squeeze cash out of to repay debt. In the current economy two of these cash drivers are early warning signs that need to be watched and talked about with every bank client. These cash drivers are more than just an indicator for your borrowers but also as and indicators for our economy in general.
During this intense period of inflation, the gross profit margin of every company, small and large, should be monitored carefully. During the next earnings season, how the gross profit changes will tell whether firms are able to pass on the price increases they are seeing from their suppliers. A shrinking gross profit margin will use up more cash than any of the other core drivers and will be the fastest way for a firm to reach a cash shortfall. If price increases can not be fully passed on, we will see declining profits as well as a strong need for commercial borrowing in the next six months to a year.
Inventory days on hand, the average length of time it takes from the purchase if inventory to the sale of the inventory is the second concerning cash driver to discuss with your clients or watch for in the reports from companies traded in the markets. There are two stresses on inventory right now. My early indicators are showing that the consumer is starting to cut back on goods purchases. This will likely show up in the reports in the coming months. For now, inventory days are just starting to lengthen as evidence of growing inventory levels. The second is one that has been existing for a while. Prior to the pandemic it took roughly 50 days for a product to go from a plant in China to out the door at a plant or distributor here in the US. Due to shipping delays as well as continued COVID shut downs in China, that time length is soared to over 150 days. Since companies have to pay for the inventory when it leaves the dock overseas, this extra 100+ days ends up gathering cash on the balance sheet of the domestic companies. Watch these two numbers as you read your clients financials or as you scour the earnings report.
The shipping industry is about to hit a snag. Over the past two years the logistics supply chain has been a mess. Ships coming from overseas are jammed in ports. Containers clogged up in ports. Truckers lined up waiting for loads and now rapid diesel price increases cutting into the margin for truckers. There are a number of larger trucking firms that are on the verge of bankruptcy as they are unable to pass on the rising cost of both labor and fuel. Smaller independent trucking firms have had trucks sitting idle waiting for loads, cutting into their revenues as well as eating up costs. There has already been an increase in delinquent truck loans associated with smaller firms and independents. As the toll begins to rise shipping will only get harder to accomplish and sadly, even more expensive.
Housing starts as well as new mortgage applications continue to grow at a rapid pace. In the past when interest rates have risen, new mortgage application as well as housing sales would fall. In most eras, housing prices move inversely with interest rates. Long term interest rates have gone up over 3% in the recent past with absolutely no impact on the new construction housing market. There appear to be two reasons for the break from the past. First are the new home buyers. As I shared last week Millennials are now purchasing more houses than any other age group. They have put off buying well beyond the normal, many have saved up sufficient funds for a down payment as well as are well established in their fields with strong incomes. Secondly, the magnitude of the interest rate increase, so far, has not moved a sufficient number of buyers into the margin where they are unable to qualify. If the fed raises the short-term rates by a half point and the market drives up the long-term rates in the next month or so, we might see the start of a slowdown.
One final note. Existing home sales levels have collapsed in a way not seen in history. This is not due to a shortage of demand, but a supply that is simply non-existent. Existing homeowners are recognizing they can not replace what they would like to sell and are simply staying put.
Take Care, have a great week.