The industry is just not structured to modify production in response to reduced demand. The industry is basically structured to go broke. David Kruse, commodity trading adviser at CommStock Investments Inc.
The above quote came from a Bloomberg article describing the current state of the swine industry. For many years, I worked in agribusiness with direct ties to the swine industry. Starting in the 80s and 90s, the industry transitioned from small herds to the modern complexes, which dominate the industry today. These modern units were designed for efficiency with the goal of becoming world class production entities. And along the way the US pork industry changed, becoming heavily tied to exports, especially Asia. Then came H1N1, and the industry hasn’t recovered yet.
The point of this blog posting isn’t about the swine industry and the economic challenges it’s facing. This post is about industries that could be structured to go broke. On the surface this is an absurd concept, since all industries and companies are structured and designed for success. Right? If they weren’t structured for success, from a Darwinian perspective they shouldn’t exist. However, I’m pondering whether the very nature of some industries/companies, predispose them to be structured for failure. What do you think?
I came up with a few idustries that might lie on success/broke fault line.
- Biofuels Industry
- Mining Industry
- Automotive industry
- International Shipping Industry
- Airline Industry
As I look at this list, some common themes begin to surface. For instance;
- High fixed cost structure
- Capacity reduction difficult and costly to achieve
- Commodity based pricing structure
- Efficiency tied to volume
In good times, these industries typically perform admirably well, often times reporting record profits. However when the economic outlook turns, their fortunes also turn. Record profits become record losses. Everyone talks about excess capacity, yet capacity reduction is slow and painful. And the return to profitabilty is equally slow and painful.
Bottom Line: Most companies find their way into financial distress due to poor decisions, weak leadership and a changing economic landscape. However, can it be that some industries are destined to go broke? I’d appreciate you thoughts and ideas.
Your post is very interesting. However, I think that those industrise are not positioned for failure, but for consolidation. When times are tough and demand is lower strong companies are able to buy out week competitors in order to gain larger share and additional infrastructure. These moves would allow those companies to become even stronger in the future.
Rodney, you are on the money with whose out-of-the-money.
Have a client of 16 years who is in three businesses: minerals (not gold!), paper, and steel. It’s a hat trick that wasn’t supposed to happen. In normal cycles under normal conditions, one always propped up the others.
Adding to that, their customers are in 3 of your 5 industries; the other themes are a grand slam.
There was no poor planning, no lack of potential problem analysis, etc. Simply a convergence of global realities and markets, the same economic collapse, fallout, and (my opinion) inappropriate governmental response, and the fact that maybe–just maybe–their part of the supply chain is dying.
Crisp analysis…people who aren’t “out there” every day may not have the same experiences and observations to synthesize what really appears to be happening.
David, I agree in concept, yet in practice, too often it doesn’t go according to plan. This is especially true when everyone is betting on “the other guy” to fold up their tent first, which simply prolongs the inevitable. When this occurs, even the last companies standing can be in such tough shape by the time a correction takes place that they’re unable to shake the noose around their neck.
Steve, great comment and insight. Thanks for adding to the dialogue.
Rodney hi it is a very interesting observation. I wonder if someone is in one of those industries what would you recommend? Do you think that a company is better of shutting down or liquidating? Or being proactive and, if the resources are available, acquire a competitor early on in the economic downturn? Or maybe there is another option I did not think about. I would like to read your thoughts.
David, I think the question you ask is relative and it depends. Warren Buffet has been a contrarian investor and it has served his investors well. However, industries that are structured to go broke are a different beast. Here the quality of the asset, the depth of the financial assets as an investment are important considerations. Playing in the structured to go broke marketplace is filled with risk, but also great opportunities. So I’d suggest err on the side of caution, and make certain you intimately understand what you’re buying and what your threshold of pain is.