Thursday, August 6, 2009

Stink boats and the forthcoming spectacular inventory bounce

Paul Krugman has been predicting a double-dip recession based on an inventory bounce. He figures that middle to latter part of this year will have an inventory bounce which will (briefly) make the economy look good again – but will not (in his Keynsian world view) bring back the fragile flower of true sustainable demand and hence will not result in sustained recovery.

That said – the inventory bounce might be very spectacular indeed. I wish to illustrate with an (admittedly) extreme example – the manufacturing of recreational motor boats (scornfully known in the Australian vernacular as “stink boats”).

Stink boats are obviously high value highly discretionary items – and they should be (and are) ground zero for the massive swings in discretionary consumption in the global economy. That said the issues in the stink boat industry are highly exacerbated by problems with “floor plan finance”.

Floor plan finance is the provision of finance to dealers (cars, boats, RVs, manufactured houses etc) to finance trading stock on the dealer’s floors. Floor plan finance has become more difficult to obtain and (far) more expensive – so dealers are responding in the rational manner which is to cut back floor stock.

By far the most extreme illustration I have seen is Brunswick Corp – the world’s biggest recreational boat maker. The stock has been a wild ride going from $45 to sub $2 and back to $8. It is operationally and financially levered to the centre of the storm…

Anyway here are some annotated extracts from the last investor conference call…

End retail sales are down 25-40 percent – see this quote:

First, let me review some of the preliminary second quarter U.S. Marine industry data, starting with fiberglass, sterndrive, and inboard boats, which fell by 34%. In the prior two quarters, the rate of decline was higher, in the 45% to 47% range. In the second quarter of 2008, units fell by 35%. Outboard fiberglass boat retail unit demand fell 30% in the second quarter of 2009. In the previous two quarters, declines were higher, in the range of 40% to 41%. In the second quarter of 2008, units fell by 25%.
However the dealers are choosing to reduce their floor-stock at least in part driven by the financing costs for this…

Now let's turn to some key factors that influenced our wholesale demand, that is, the boats we sold to our dealer network. In addition to the underlying retail demand, another factor that is having an effect on overall wholesale demand is the availability and cost of floorplan financing. Several traditional floorplan lenders have exited the market, or materially reduced their exposure, and the remaining lenders have imposed stricter lending criteria as they seek to protect the quality of their loan portfolios. Although Brunswick dealers continue to benefit from the financing availability provided by BAC, our joint venture with GE, beginning April 1, dealers became subject to revised terms, including higher financing costs and loan curtailment payments. These changes translate to higher costs for dealers to carry inventory, which has led Brunswick and our dealers to reassess and ultimately reduce wholesale orders. This will ultimately lead to a healthier marine environment, with lower inventory levels held in the dealer system.

The net effect is that they have reduced their sales to dealers by 60 percent – see this quote:

In response to these market factors, and our strategy to do all we can to protect our dealer network, we have reduced the number of units that we sold to dealers nearly 60% in the second quarter versus last year. This is the same percentage decline experienced in the first quarter of 2009.

As a result of our reduced wholesale unit levels and the impact of higher discounts, Brunswick's boat segment sales declined by 77% in the second quarter, compared to the decline of 64% in the first quarter of 2009.

But it gets worse – the company has stripped itself of inventory –

As we execute our strategy to maintain high levels of liquidity, and assist the dealer network in this weak Marine market, our production rates during the quarter were well below our wholesale unit sales. This lower network production reflected about a 75% decline in units produced versus the second quarter of 2008. This compares to our 60% decline in the second quarter wholesale units, which I have previously mentioned. More importantly, in our fiberglass boat businesses, our production levels were about 13% of our retail demand, and in our engine business, overall production was reduced by approximately 65%, this follows a 75% reduction in the first quarter.

So what do we have

• End sales down 30 percent

• Dealer sales down 60 percent

• Production down 75 percent

Or – as they put it

We produced 13% of what the dealers actually retailed, in terms of even numbers.

Obviously these numbers are unsustainable and either retail sales have to dramatically fall from current levels (unlikely) or production has to grow dramatically...

How else do you spell inventory bounce?

My guess is that the inventory bounce here will be so big as to restore pricing power to (of all things) luxury recreational motor boats manufacturers.

This looks like a V-shaped recovery – at least for stink boat manufacturers.

Whilst there are inventory shortages in far more important industries (see this story from the WSJ about auto-dealer inventory shortages) they won’t quite be of the scale of Brunswick. But the risks to the inventory driven manufacturing economy are in my view (and quite surprisingly) to the upside.

Whether Professor Krugman is right - and the inventory bounce is followed by a double-dip - on that I will reserve judgement. But he is right such a large proportion of the time that when the euphoria of the inventory bounce is upon us I will be very nervous...


Deepish Thinker said...

If only Congress would hand out billions in subsidies to people willing to trade in (and sink) their old clunker stinkboats we might might get ourselves a real recovery

Brick said...

This is not your typical manufacturing company though, although I would suggest it has similarities with the car industry. It is not typical because the time between manufacturing and sale to the consumer can be quite large(six months or so) where as most consumer manufacturing is on a shorter time scale. The consequence of this is that industries will get an inventory bounce on different timelines. Much of the stuff on your supermarket shelf may well already experienced its inventory bounce while long distance exports or imports should expect the bounce in the future.
One of the missing ingredients from your example is the seasonal impact and we cannot be sure that end demand will not fall a further 40 percent once the summer is over. What I do think this shows is that seasonal restocking has changed in that retailers are ordering on shorter timescales rather than bulk reordering in preparation for the season. This could have a big impact in the run up to Christmas with ordering not picking up as expected early in the season.
It is all a bit swings and roundabouts with individual market sectors getting a rebound while others begin to decline again.

Dan said...

mmm... interesting. I'm sorry if my rather classical economic education rather simplifies my thoughts on this, but a decrease in supply, a forecasted pick up in demand - it all points to a massive up tick in inflation. Which in turn leads to interest rate rises - and bang we are back where we were in 05, 06. The carry trade will be put back on, which in turn will lead to excess leverage and we will go through it all again. Each boom is characterized particularly in the Financial media by a theme, .com, china, commodities etc. I wonder what theme/industry will characterize this fast approaching boom period?

Nemo Incognito said...

Could not agree more. The oddities I am seeing in the commodity space continue: China hits new record for copper imports but Oz Minerals' refining charges are down a cool 45%, which means that either 1) Something is up with OZ or 2) China is stockpiling a mofo amount of copper which is either going to be drawn down by end users or which is going to find itself as a very large inventory in need of writing down at Chinese smelters. Time will tell. End users could whiplash refiners and finished products companies but its unlikely to be able to take out these monster stockpiles.

Anonymous said...

Its an intersting view and it works in this one example, but one example does not make a whole economy. Albert Edwards made this comment in his recent strategy piece : "The inventory liquidation, although large in $bn terms, has NOT
been excessive given the unprecedented 18% collapse in sales. The rate of inventory decline, at 8% yoy, has barely exceeded that seen at the nadir of the last shallow recession in 2001/2 when sales fell only around 5% yoy. Manufacturing and wholesale
inventory/sales ratios are still excessive"

But What do I Know? said...

Another takeaway from the call is that financing costs for Main Street are going higher while cost of funds for the banks remains very low. I think this happened in Japan in the nineties as well. Doesn't anyone in Washington understand that the cheaper credit has to get out into the hinterlands for new businesses to begin or existing ones to grow? Anything else is just paying the rentiers.

Schweizer said...

There is NO inventory build-up currently based on the weekly reported railroad loaded units, which is still declining steadily.

These guys predicting an inventory build need to stop speculating and look at real numbers.

Bullish In Boise said...

Well, let them be party poopers in Princeton. The true pulse of the American consumer is how crowded the Whole Foods' stores are on Saturday morning and how much $28.00 per pound Yukon smoked salmon candy is purchased for Sunday brunch.

"Cassandra" said...


I thought the international term was Stink "Pots". That is certainly the term for the large boats used by their more cynical skippers and some of their more discerning owners. Of course you Aussies might have your own vernacular of the same concept for the smaller hulled toys.

Pedantically Yours....


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