Saturday, May 10, 2008

Risk Update II – Forward View Of The U.S. Economy

On April 7, I wrote Risk Analysis Update – A Forward Looking View Of The U.S. Economy, where I listed events to unfold due to the current recession. While I was projecting events to occur well into the 1Q 2009, some of the events have already occurred or are in the process of occurring:

Forecasted: Some companies will reduce the portion on their products and offer it the consumers as being ‘new and improved’

Occurrence: “T.G.I. Friday's, Quiznos and Au Bon Pain and other "fast-casual" restaurants have introduced smaller, cheaper alternatives” – USAToday, May 10

Update: Expect more of downsizing of portions to continue

Forecasted: Restaurants – people will be eating out less frequently and opting to go to lower-cost ‘family style’ restaurants to cut costs

Occurrence: “Struggling with soaring food costs and cash-strapped customers, restaurants across the country are swapping expensive ingredients for cheaper fare and adding new dishes that won't break their bottom line.” – Chicago Tribune, May 10

“The weak dollar is hammering restaurants that buy such imports as French cheese, Italian olive oil and European wines. Add to that, belt-tightening by customers caught in the slowing economy. Ruth's Chris Steak House saw fourth-quarter profit in 2007 fall 62% compared with the same period a year earlier. Similarly, fourth-quarter profit was down 48% at Domino's Pizza and 35% at the Cheesecake Factory.” – WSJ, May 8

Update:A lot of restaurants will go out of business as more and more people opt to eat at home and to bag lunch. Restaurants are desperately trying anything possible to keep from closing. However, replacing ingredients will only provide small and short-term relief as people begin find dining out at low-end restaurants (McDonald’s, Denny’s, etc.) to be an acceptable replacement.

Do expect to see more portion control and ingredient replacement tactics. Also, expect to see more of the gimmick advertising to draw people in. Such gimmicks like far-below cost pricing, two- or three-for-one, and return of the blue plate specials.

Forecasted: Motorcycles & Scooters – Low fuel consumption and low cost will be the draw

Occurrence: “Sales of fuel-efficient motor scooters jumped 24% in the first quarter of 2008 over last year’ – USAToday, May 9

Update: As the weather warms up, see more people venturing to commute on scooters and motorcycles

Forecasted: Automobile manufacturers – with people opting to stay with their car for a few more years, car sales will suffer. Big cars and SUVs will be hit the most, even if they are touted as being a hybrid. The bottom line is the rising fuel price

Occurrence: “High fuel prices are causing the value of used SUVs to plummet, often below what's listed in the buying guides many shoppers use to negotiate with dealers.” - USAToday, May 8.

Update: Trucks, cars with low MPG, and cars that only uses premium high octane gasoline will also rapidly lose their value as people realize that paying $100 for a fill-up isn’t worth it anymore. Even now, if one does a search for new cars with fuel economy up to 15 MPG on Yahoo Auto, it will list 109 vehicles. Most of these are trucks and large cargo vans. However, there are a good representative of cars, mostly muscle and sports cars. These will also lose value rapidly as people will shy away from them to save money at the pump.

Forecasted: FedEx and UPS – Trucker strikes, rising fuel costs, and reduction in delivery, all contributes to lower revenue and challenging times

Occurrence: “The steep rise in the cost of fuel is all the more painful with overall demand for package and freight services slumping due to the state of the U.S. economy.” – MarketWatch, May 9 on FedEx earning

Update: This is only the beginning of more bad news for the overnight delivery companies. The demand for deliveries overall will drop in the U.S. and Europe. The pick up of revenue in Asia will not be sufficient to make up the shortfall. Look for a possible JV talk between FedEx and DHL (a wholly owned subsidiary of Deutsche Post World Net)

More Forward Looking Views
There is a benefit of the current high price of gasoline and recession:

  • More people will get healthier as they cut back on consumption and use mass transportation and alternative means for commuting
  • Traffic should reduce, as more people car pool, take mass transit, or limit the use of their cars
  • As traffic reduces, air pollution will lessen
  • As traffic lessens, demand for gasoline will drop, resulting in a slow down in the price increases
  • Inner cities and locations closer to employment centers will see a revival as more people realize that long commute is killing them at the gas pump
  • Car companies will begin to advertise fuel efficiency again, instead of power and speed
  • Use of coupon will be in vogue, again
  • Second hand thrift stores will gain in popularity; shopping there will no longer mean being poor, just thrifty
  • As more people being to look for was to save, there will be more recycling, reducing the amount of garbage being dumped into landfills
Areas Of Concern:
  • More people will start cutting back on services, including haircuts, nail salons, dry cleaning, house cleaning, pool cleaning, lawn services, as they begin to do it for themselves or reduce the frequency of the service
  • Organic food companies will see sales slowing as people begin substituting them non-organic products
  • Rate of people charging on their credit cards will go up. Initially, this will be perceived as consumer strength. However, it is a sign of consumer’s financial weakness. More and more people will use credit cards to make ends meet and then begin defaulting on them
  • Builders of McMansions won’t be able to sell these houses as people shy away from them for four major reasons: inability obtain the mortgage, high maintenance cost, high taxes, and high costs of commute
  • Sellers of houses in planned developments located far from employment centers will have to reduce their asking price much more than those selling in developments with access to mass transit or are located close to employment centers. Reason is simple: high cost of commuting, especially gasoline
  • Makers of bottled and flavored waters will see sales reduced as people find it chic to drink tap water again. After all, Dasani, Aquafina, and a lot of other bottled waters are made from tap water.

Ed Kim
Practical Risk Manager

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