The Winds of Change

The past few years have been a “golden age” for independent converters, and I have been urging them to take advantage of the most favorable market conditions I have seen in my 30-plus years of experience with this business. It’s been a great run, and seemingly everyone did quite well. For most of you, sales and margins improved, and while some costs rose significantly, in general, profit levels improved greatly.

The gold standard of profitability for independents had always been a return on sales of 15%, but over the past two years, I have seen margins of 20% and higher. Paper was scarce for a while, lead times for orders went from days to weeks, and overall, converting capacities were challenged in almost every regional marketplace. Customers were far less concerned with price and far more concerned with lead times and delivery schedules.

Well, conditions seem to be changing fairly quickly. Paper has gone from being scarce to being plentiful, and millions of tons of new capacity are scheduled to come online soon. In addition, our traditional containerboard export partners in Europe, Mexico, and South America also have millions of tons in new capacity starting up. Demand for boxes also seems to be waning, with many boxmakers reporting that their volumes have gone down in the past few months. The Federal Reserve seems committed to fighting inflation by raising interest rates, which will certainly have a negative effect on the economy. This will likely depress box demand as well. Finally, much of the new equipment ordered in the past 18 months is beginning to be installed, and there will be additional converting capacity in almost all regions of the country.

In my experience, most independent converters lose margin when the published price of containerboard comes down. While we may be a long way from that happening, all of the capacity starting up in our markets and in our export markets in the face of slowing demand is not exactly a good omen. Our integrated friends are going to have to do a lot of heavy lifting to ensure this does not occur; this may include shuttering some older and less efficient mills. So, in the face of increased converting capacities that will make things more competitive, cost inflation that is still not under control, and rising interest rates and a glut of paper that threatens overall margins, what should an independent converter do?

The first order of business involves an introspective look at your operations and some basic planning. I recommend you model your business going out 12 to 24 months with slightly decreasing sales and margins. Do a couple of cases and see what your profit levels look like. Look at it from a cash flow point of view as well to ensure you have sufficient cash reserves and liquidity. Remember, interest rates are going up, and that will have an impact on your bottom line. The larger companies have been sending orders to their smaller competitors, and this is likely to slow down or stop, so you need to determine how much of this type of business you are currently running and what your business may look like with less of it. You need to come up with contingency plans for what your modeling tells you may happen and consider such concerns as:

1. Is it time to go from a three-shift to a two-shift operation on some or all of your machine centers?
2. Should you consider outsourcing some business you are currently running inefficiently?
3. Do you have extra people anywhere in your operation?
4. Should you renew the lease on extra space you have been carrying or consolidate your operation?
5. Is it time to cut inventory levels?
6. Is it likely some customers may start paying more slowly in the face of weakening overall market conditions?

You also need to take a look at your own customer base and converting capacities on an order-by-order basis and a customer-by-customer basis, and ask yourselves questions such as:

1. Have we taken on business that really doesn’t fit our plant and equipment configuration?
2. Is too much of our mix trade business more vulnerable in a business downturn?
3. Have we stretched our converting capacities too thin during the boom of the past few years, and is it time to cut back on some less profitable accounts?
4. Where are we vulnerable in the marketplace due to the multiple price increases of the past two years?
5. Do we have any planned investments in people, equipment, or facilities we should reconsider?
6. What will our business look like if we lose some of our major customers?

Those of you who have significant cash reserves and liquidity may find that the machinery markets are going to change significantly. Higher interest rates, possible tightening of credit by the banks, and weakening business conditions may provide opportunities to acquire equipment at more favorable prices, terms, and lead times than in the past few years. Companies with strong balance sheets may find significant opportunities in the marketplace during a downturn, and this may be part of your business calculus as well. It may be a good time for such companies to look for M&A candidates or buy equipment to broaden their lines of business. Strong companies often do well in these areas during a downturn because everyone else is hunkering down to try to preserve what they have.

Based upon the business modeling and the introspective analysis of your business, you may want to contemplate some immediate changes to your previous plans or at least have some contingency plans in case sales and/or margins begin to show some deterioration. The winds of change are upon us, and it is time to consider reacting to them. Remember, the failure to plan can often become a plan to fail.

Mitch Klingher is owner of Klingher Nadler LLP. He can be reached at 201-731-3025 or mitch@klinghernadler.com.