It’s Time To Get Your Balance Sheet In Order
January 17, 2022
Ross Waetzman, CIRA, CDBV
Director
Corporate Recovery
In the four weeks since I last wrote my 2022 Outlook, reported Q4 corporate earnings have been overall strong at 27.2% over the prior-year results. This is counterintuitive given January’s reports that the average producer absorbed 2.7% of higher costs from consumer pricing.
At this point in the pandemic, successful companies have gotten leaner and more resilient, particularly with labor and supply shortages. Now right-sized, these firms are positioned to generate more substantial margins with lower volume—an unthinkable pre-pandemic model.
Supply shortages will not readily abate. Auto dealerships report two to three buyers for every car in inventory. At the same time, both the dealers and original equipment manufacturers (OEMs) are more profitable than ever; there’s little incentive to hold more inventory.
The Fed’s challenge is that neither rate hikes nor the sale of fixed income assets from its balance sheet—the unwinding of Q.E.—quickly addresses product shortages. Either tool drives higher rates but at a societal cost:
1) Low-income individuals and corporate borrowers are less equipped to handling rising rates, and
2) Quickly rising rates could pop security asset bubbles, triggering a recession.
The Fed may be hesitant to kill inflation too fast for another reason: U.S. indebtedness. In 2016, the U.S. debt was 104.5% of its GDP. Today, U.S. debt is $11 trillion higher, growing 25% faster than GDP and raising the U.S. debt-to-GDP ratio to 124.7%.
If all else remains constant, new inflation should, in theory, grow GDP faster than new debt issuance. Combined with the adverse impacts of rising rates, it’s possible higher product pricing will be around for some time.
This sets up a recurring message for struggling corporate borrowers. If they cannot absorb or pass higher costs onto consumers, the consequences of their higher leverage may outweigh any benefits reaped from inflationary times.
The drum’s beat has not changed since the outset of the pandemic (i.e., developing resiliency), but the time of reckoning is drawing ever near. For borrowers, it’s time to get your balance sheet in order.