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Working capital burdens slow the middle market's ability to throw off cash as it grows.
David M. Katz, CFO.com | US
November 18, 2011
In many industries, the companies best built for cash-generating growth are middle-market companies. Such companies tend to be more streamlined than the giants and thus have fewer assets to fund. At the same time, mid-market companies can leverage more market power with their suppliers and buyers than their smaller competitors can.
One anomaly, however, is the transportation industry. To be sure, the industry stacks up about evenly with other nonfinancial-services industries in term of its ability to produce free cash flow as it grows, according to CFO's Free Cash Profile (FCP) snapshot of software makers. Developed by Charles Mulford, a Georgia Tech accounting professor, the FCP snapshot using company data for the 12-month period ended nearest to June 30 provided by Cash Flow Analytics LLC.
Overall, the industry — as represented by 96 railroad, trucking, terminal management, water transportation, air transport, pipeline (excepting natural gas), and transportation-services companies — shows a median free cash profile (FCP) of 4.52%, which is in line with the all-industry median FCP of 4.95%. (Broadly speaking, FCPs measure the ability of a company or an industry to generate free cash flow as it grows. To learn how FCPs are calculated, see "How the Free Cash Profile Works," below.)
But a look at the middle market tells a different story. The 21 companies with revenues of between $300 million and $800 million that are part of the snapshot have a median FCP 1.08%, clearly underperforming the transportation industry as a whole.
Whence the mid-market nosedive? The answer is twofold: relatively speaking, such companies are caught in a working capital squeeze and lay out hefty amounts of capital expenditures. They must allot 3.93% of their revenues to operating working capital, for instance, compared to an industry median of -.72%. Further, the middle market allots 6.14% of its revenue to capex compared to an industry median of 4.35%.
The working capital situation, in particular, suggests an area in which middle-market transportation finance executives can improve their companies' ability to spawn extra cash flow, according to Mulford. In short, such companies are caught in a vice: while their suppliers are taking eight days on average longer than the industry median to pay them, the companies are turning around and paying their suppliers eight days faster than their industry peers.
The CFOs in this group "need to look at collection policies and terms, and work at getting paid sooner, because they're underperforming the industry," says Mulford.
Among the middle-market firms, Orbitz Worldwide has the highest FCP, 36.37%. You could argue that Orbitz resembles an internet, software, and marketing firm more than a capital-intensive transportation company, the professor suggests. But many components of the company's FCP track those of the median mid-level transportation company: Orbitz's capex-to-revenue percentage is 6.07%, compared to 6.14% for the mid-market firms and 4.35% for the industry as a whole. Further, the company's operating cushion is 16.25%, vs. 18.31% for the middle-market firms and 11.61% for the industry.
At the same time, Orbitz's stellar FCP is partly driven by a working capital performance more characteristic of a software company than a transporter: the company's percentage of operating working capital to revenue is -26.34%.
Much of the lightness of its working capital load stems from its ability to get paid in advance, another feature of online companies. Thus, 6.05% of Orbitz's revenue is deferred. The median deferred revenue percentages for the middle market and the industry as a whole? Zero and zero.