The working capital crisis: Kohler

Watching interviews with crestfallen Pacific Brands workers on the TV news last night was heartbreaking; you knew these people were not going to get another job and that the dole, at $255 a week, is not enough.

Those watching and reading about the Pacific Brands convulsion would be excused for thinking Australia is in recession. It’s not, but almost certainly will be soon – largely because of the depressing effect of events like yesterday’s.

Although this company is suffering a margin squeeze as sales shift from specialty retailers to discount stores, Pacific’s immediate problem is debt, not sales and margin.

Specifically it is interest cover, which has slipped to the debt covenant limit of 3.5 times. This has put the company in the hands of its bankers and they require the cancellation of the dividend and significant cost cutting to ensure that interest cover is maintained.

But closing Pacific Brands’ remaining Australian factories and shifting production offshore is a very risky strategy, both for the banks and shareholders.

On the one hand manufacturers in China, Indonesia and Taiwan are now desperate to do sharp deals with firms like Pacific Brands because exports in these countries are down by as much as 50% (in fact, everywhere but China so far), but on the other hand Pacific Brands will now be highly exposed to a currency that looks ready to sink again.

The CRB commodity price index is 58% below its peak, and the collapse in Asian exports and global trade generally has removed any prospect of a short term recovery in commodities.

The Australian dollar has been sitting around US65c for more than four months as foreign exchange markets waited for confirmation of the global recession. That’s now in. The Aussie dollar looks ready for another leg down.

If, or perhaps when, that happens, unhedged importers will be hit by big cost increases to go with the margin squeeze caused by the swing to discount retailers and a decline in consumer spending.

Many more firms will be hit by a working capital squeeze as they try to service debt at the same time as buying parts and stocking their warehouses with foreign products paid for with Australian dollars worth less than US60c.

And, like Pacific Brands and OZ Minerals, they will find unsympathetic bankers when they ask for help to “get over the hump”.

To that extent both Pacific Brands and OZ are symbols of a credit crisis, not of recession. This might seem a fine point, but it’s important.

Our political leaders, when they can spare a moment from slagging each other off and engaging in the most pathetic spin, and to the extent that they are doing anything useful at all, are focusing on the symptom, not the cause – on consumer spending and employment, not credit creation.

By far the best action taken thus far by the Rudd Government was the government guarantee of authorised deposit-taking institution liabilities, not the two so-called stimulus packages, which are transitory or slow.

But it has only partially worked. Banks the world over are now in a paradoxical state of being both demoralised and voracious; their great supremacy has turned out to be an illusion but now, ironically, they are more powerful than they have ever been, and are determined to make the most of it.

The “Rudd Bank” to be run by Ahmed Fahour is a good start to turning this situation around, but it is a joint venture with banks.
It is ironic that companies have lately been finding it easier to get equity out of super funds and retail shareholders (discounted) than debt out of banks.

Why are super funds investing in shares when they can buy the same company’s bank debt for 60 cents in the dollar? That’s what debt is commonly selling for now.

There must be some way of mobilising the nation’s massive superannuation pool to support credit creation as well as equity.

This article first appeared on Business Spectator