Risk Management

Benchmarking Credit Risk: Cash Is the Key

Compared with the same period last year, fewer midcap companies were slow to pay their bills in the third quarter of 2009.
David KatzDecember 9, 2009

Editor’s Note:
For a look at how three dozen industries are faring on key metrics associated with timely payment of invoices, check out the
2009 Credit Risk Benchmarking Report.

On the heels of a two-year economic downturn, most midcap companies are throwing off enough cash from their sales to be able to pay their bills on time, according to the third-quarter update of CFO’s 2009 Credit Risk Benchmarking Report.

In the third quarter of 2008, with Lehman Brothers collapsing and credit freezing up fast, the portion of midcaps that saw their cash performance decline compared with the year-ago quarter jumped from 40% to 47%. Perhaps as a signal of an improving economy, however, that trend has turned sharply: the percentage of companies with poorer cash performance (cash as a percentage of revenue) has dropped to 38%.

Midcaps’ increased ability to translate sales into bankable cash seems to have enabled them to pay their bills a tad more quickly. The portion of companies that saw a rise in their days payable outstanding — indicating tardiness in bill paying — dipped from 45% in Q3 2008 to 42% in Q3 2009.

Just 16% of the 550 companies culled from the CFO Midcap 1500 for the report could be dubbed credit risks in the third quarter of 2009 — down from the 18% that spawned such anxieties in the third quarters of 2008 and 2007. (The CFO Midcap 1500 consists of publicly traded companies headquartered in the United States that have annual revenues ranging from $100 million to $1 billion.) Companies may be credit risks, according to the report, if they deteriorate in three categories compared with the same quarter of the previous year: cash as a percentage of revenue (aka cash performance), days payable outstanding (DPO performance), and the company’s DPO as compared with its industry’s DPO.

Midcaps boosted their cash performance in 2009 in a number of ways. B&G Foods, for one, a $500 million maker of foods that have long shelf lives, saw its cash performance skyrocket by 247% and cut a day off its DPO in Q3 2009 compared with the same period last year. The cash-performance hike was fueled by low interest rates that cut the company’s debt payments and by the cash that B&G got from an equity issuance, says CFO Robert Cantwell. B&G used that cash to pay off debt, a move that reduced its interest expense and “effectively put more cash on the balance sheet,” he says.

Over a longer term, B&G has generated cash by keeping its capital spending low — about $11 million a year, a fairly low figure as a percentage of sales in the food industry, according to Cantwell. Partly as a cash decision, partly as a cost decision, the company has chosen to outsource the manufacturing of about a third of its products. “That has allowed us to not support with capital spending about a third of our production, which keeps our capital spending low,” says Cantwell.

Looked at by industry, the bleeding among companies seeking credit from suppliers seems to have been contained. The portion of the 37 industries studied in the benchmarking report that could be called credit risks dropped to 8% in Q3 2009 from 17% in Q3 2008. (Fourteen percent sent out warning signs to their creditors in 2007.)

Why has the number of industries with credit-warning signs dropped? “You had that recessionary purging of the industries,” points out Chris Kuehl, the National Association of Credit Managers’s (NACM) economist. “Some of the industries have shrunk to the point that some of the survivors are doing well.”

Kuehl notes that the purge can also be seen at the company level — in residential home building, for instance. “That has been down for so long that the bad players have essentially been eliminated, and all you really have are the serious ones who have consolidated themselves back into health,” he adds.

Among the 37 industries in the report, just 3 signaled to suppliers that they might have a tough time getting paid. Those 3, the only industries studied whose cash and DPO performance deteriorated in 2009, were household durables, metals and mining, and pharmaceuticals.

Even in those areas there were high-flying outliers. In the lagging metals and mining industry, which saw its aggregate DPO slow by 4 days, Universal Stainless & Alloy Products pumped up its cash performance by 607% and knocked 10 days off its DPO. Similarly, in the risky midcap pharmaceuticals sector, Impax Laboratories lifted its cash performance by 4% while shaving 19 days off its DPO. (The finance chiefs of Universal Stainless and Impax had not returned calls at press time.)

As credit risks, midcap companies fall into three broad categories in terms of their fate over the past year or so, according to the NACM’s Kuehl. (About 65% of the 1,000 companies the trade association looks at for its monthly Credit Managers Index fall into the midcap revenue range, he notes.) In one category, which comprises a fourth to a fifth of midcaps, companies “are struggling,” he says. “They are going to have a hard time making it through the next year. They may be merger or acquisition candidates.” Many are in the automotive or construction industries or in companies that supply those sectors.

In another category, the biggest (about half of the NACM’s midcap survey base), companies “have been pretty conservative, have been paying attention to their accounts receivable, and seem in pretty good shape to take advantage of a recovery next year,” says Kuehl.

Companies in the last category, including those in the health-care services, manufacturing, and energy sectors, never really experienced much of the recession because their goods and services have remained solidly in demand. When Kuehl talks to credit managers in the medical fields about credit risk, “they’re almost embarrassed,” he says. “They say, ‘We’re doing fine; the whole country is getting older and wanting health care.’”