Getting Stronger in a Recession?

While most of us suffering huge loss a recession brought, there’re indeed some companies enjoy the rare opportunity in the recession.

They turn a recession to its advantage, increasing the value of their franchises considerably. Who are they? The ones that are leaders in their industries -- companies with strong brands, higher margins, and prudent levels of debt. For these companies, a recession may end up being one of the best things that could happen.

How do they do it? Three ways:
**Competitors go out of business.
**Companies increase their earnings per share through share repurchases or acquisitions at bargain prices.
**Continued internal investment leads to increased market share and productivity gains.

1) Becoming king of the world
The most direct way a company can benefit from a recession is pretty simple: Competitors go bust. Best Buy will probably benefit from Circuit City's liquidation just like Toyota Motor would benefit if General Motors went under -- because removal of that supply from the market would increase demand for competitors' cars.

2) Buying up value
Share repurchases and acquisitions are another way value can be created. In a recession, asset values typically fall to historically low levels. A company with a strong cash position can scoop up its own shares or make acquisitions for very low prices.

This is beneficial because buying shares at low prices reduces shares outstanding. The same earnings over fewer shares equal higher earnings per share -- and, theoretically, a higher stock price.

For example, The Washington Post generated a mind-boggling amount of value for its shareholders in the 1970s when it (at Warren Buffett's suggestion) repurchased vast quantities of its shares at prices well below what it was worth. Similarly, buying a business at a depressed price can add to a company's earnings per share, and the lower prices mean there is more cash for shareholders -- and all of that means benefits down the road.

That's what MidAmerican Energy was trying to do when it agreed to buy Constellation Energy when the latter was having liquidity issues. MidAmerican agreed to buy the whole company for the bargain price of $4.7 billion, but the deal fell through when Constellation found someone willing to pay $4.5 billion for half of its nuclear power business.

Even though it didn't end up acquiring a quality asset on the cheap, MidAmerican stands to earn more than $1 billion on the $1 billion it initially lent to Constellation.

Having the flexibility to invest in one's own shares and those of distressed companies can give a company quite an edge.

3) Internal investment
All businesses need to continually invest in themselves in order to improve. This is because investments in areas like research and development and productivity initiatives should lead to higher sales, lower costs, and hence, higher margins.

Yet in a downturn, less-well-off companies are forced to put off these expenditures because the more pressing need is to keep the business profitable. But companies with high operating margins and strong cash flows can continue to invest in themselves when times are bad, and therefore have opportunities to gain over their weaker competitors.

You can see this in the automotive industry. From 2002 to 2006, Toyota's operating margin ranged from 7% to 10%, whereas both Ford's and General Motors' ranged from negative 5% to 3%. Toyota's margins were higher because it invested heavily in automated production systems and lean manufacturing initiatives over many years and, as a result, was much better positioned to weather the current crisis than its American competitors.

Investing in yourself -- especially when your competitors can't -- usually leads to a payoff down the road.

Follow the best
So for investors, It’s important to identify now the companies that will likely enjoy these advantages going forward. A large cash balance is one sign of a potential winning investment in an uncertain world, because it can protect the company against unforeseen difficulties or allow the company to play offense by buying back shares or acquiring competitors.

1 comment:

  1. You can always make money even more so during recession if you can identify particular companies which are going to follow the trend and benefit from some short term gains.


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