February 3, 2016
As independent packaging converters make their ongoing assessment of customer and supplier market conditions, inventory of raw materials or finished goods is often the point at which the market pulse is taken. Inventories significantly lower than historical norms often signal that demand is rising faster than anticipated, while abnormally high stock levels offer evidence that production has gotten ahead of demand.
In the past, inventory-led recessions have caused the most difficult business conditions faced by boxmakers. As already-boxed goods stack up in excess of demand in retail, wholesale, and manufacturing warehouses, demand for new boxes falls off sharply. Even after final consumer demand recovers, it may still be several months before excess inventory is cleared out of warehouses. So long as consumer needs for goods can be supplied from accumulated stocks, no new boxes are needed to package freshly produced goods.
At the national level, closely watched inventory data are published by the U.S. Census Bureau based upon monthly surveys. While absolute inventory levels are important, the most effective measure is to examine inventories relative to sales in total and in each of the major supply chain divisions: manufacturing, wholesale trade, and retail trade. The chart above displays inventory-to-sales ratios in months of supply for the total U.S. supply chain.
During periods of manufacturing recessions, sales fall off far more rapidly than production and stocking of goods, causing the inventory-to-sales ratio to rise rapidly. Throughout the actual manufacturing recession and often well into the economic recovery, inventories are worked down relative to sales as sales pick up and production remains lackluster. The green-shaded areas of the chart identify periods when manufacturing activity contracted in the United States, according to the Institute for Supply Management.
During the most recent recession, the inventory-to-sales ratio jumped from 1.23 months to 1.46 months, a 19 percent gain in about six months. It took aggressive cutbacks over the next six quarters to reduce inventories relative to sales back to prerecession levels. From 2010 well into 2013, U.S. manufacturing flourished, as domestic firms regained global competitiveness in many sectors. Inventories were well-managed relative to sales during that period, remaining within historical norms for periods of manufacturing expansion.
However, in mid-2014, the U.S. dollar began a relentless march upward against almost all of the world’s major currencies, as economic growth slowed outside the United States and investors increasingly sought the relative security of U.S. dollars. As manufacturing output slowed and U.S. consumption failed to grow more rapidly, inventories rose relative to weaker sales growth. During December, U.S. manufacturing activity contracted, as measured by the monthly survey of the Institute for Supply Management. Relative to sales, inventories throughout the U.S. supply chain are now higher than at any time since the recession. While not at recessionary levels yet, this statistic is a flashing yellow light that warrants close attention.
The chart below shows U.S. economic growth by major contributing sector. Notice how significant an influence liquidation of inventories had on the third quarter’s GDP growth. Inventory reduction subtracted nearly 1.5 percentage points from the initial estimate of economic growth. Simply put, if that inventory drawdown had not occurred, the reported growth for the quarter would have been 3 percent rather than 1.5 percent. However, even this aggressive liquidation of inventories was insufficient to keep inventories from rising relative to sales during the third quarter, when they measured 1.38 months at the end of October.
The corrugated industry and its independent converters are facing a similar situation. Early in the fourth quarter, stocks of containerboard at mills and box plants were approximately 10 percent higher than levels a year earlier. During the two-plus years since the end of 2011, the long-term trend line of stocks measured in weeks of supply has drifted up from around 4.0 weeks to 4.4 weeks, a 10 percent increase. And, as the chart below shows, inventories have almost always risen early in the year, a period of relatively slow demand, to be reduced as the year progresses.
This year, however, there was no meaningful midyear reduction, so inventories entered the fourth quarter abnormally high. Increasing the difficulty of significantly reducing stocks near year-end is the fact that both November and December have fewer shipping days than other months due to holidays in each month. That increases the difference between mill shipping days—they tend to run every day—and box plants, which usually close for holidays and weekends.
During the last two months of 2015, mills operated for 11 more days each month than box plants. Over the past 10 years, the average January inventory change has been an increase of 146,000 tons, the highest upswing of any other month. An increase of stocks even close to that amount this January will send containerboard inventories to their highest level ever, at a time when inventories remain swollen throughout the supply chain.
Dick Storat is president of Richard Storat & Associates. He can be reached at 610-282-6033 or storatre@aol.com.
