How do we stack up?
As you know, I have been involved for many years in the material handling industry, the construction equipment industry and the equipment rental industry. It has been a very interesting and educational ride leading me to totally respect all the players in these industries.
What I find so interesting about the material handling business is how many dealers respond to competitive and economic headwinds and still survive to fight another day. There is no doubt in my mind that a material handling dealer is working a business in a tough industry. One of the toughest to manage, and to manage successfully. I say that because you compete in a competitive market with excessive OEM options available, at least five profit silos to manage, managing capital intensive products and services, and to top it off, finding yourself in a very competitive situation for personnel to operate the business. With a lack of qualified techs and most sales candidates coming in with a non-compete agreement they signed, being able to attract and keep quality people must be one of the major stumbling blocks you face. All in all, a tough business to work in and still produce above average profits and cash flow.
Consequently, I often wonder how a business such as yours, in such a very competitive industry with major capital and personnel needs, stacks up against other industries in terms of investment potential. So, when I came across an article outlining how to measure potential investments, I could not resist the temptation to see how the material handling business measures up against the expected “results” of the four test categories noted in the article.
These four calculations are used to evaluate the quality and value of almost any business or industry. Doing the calculations and reviewing the results will help quantify exactly what makes a given business great, average or poor.
#1 High Profit Margins
The question is how much cash you generated from operations, which is different than total changes in cash balances. The goal is to produce cash flow from operations against total sales of at least 20%. You can get “Cash Flow from Ops” right off your year-end financial report. Then run the calculation
CASH FLOW FROM OPS/ TOTAL SALES = %. A 20% result puts you in World Class Business status
#2 Capital Efficiency
This could be a tough one. Let’s see.
Capital efficiency is defined as how much capital the business needs to maintain its facilities and growth of its revenues. A capital efficiency company generates excess cash for distribution to owners or to support growth. What is expected is more excess cash available for owners and growth compared to Cap-X requirements. In other words, cap X of less than 50% of Cash Flow from Operations.
In your case Cap-X covers rental assets, facilities and other long-term assets such as delivery equipment, shop machinery and technology. It does not include inventory as Cap-X. Using this definition makes it easier to attain. And remember, transferring inventory to rental assets should be considered Cap -X at that point.
#2 Goal is to keep at least 50% of Cash Flow from Ops net of Cap-X for the year.
#3 Return on Invested Capital
This one is easy to calculate. Again, I would use the year-end report. It is a metric to determine the value and power to shelter your business from profit-eliminating competition.
Calculate as follow: Equity plus LT Debt / net income. Goal is to shoot for 20%
I suggest that any calculation using net income be normalized to eliminate “personal” expense as well as one-off transactions. The same type of adjustments you would make valuing the company for sale.
I know some dealers use unclassified balances sheets, especially if they have large rental fleets, because the short-term amount of the fleet debt creates negative a working capital which must be explained to banks and other financial institutions. If you have an unclassified Balance Sheet, you may want to run this calculation both ways.
#4 Return on Net Tangible Assets
This is not as complicated as it sounds unless you have a material “goodwill” amount on the balance sheet.
This calculation gives you the best overall measure of the quality of any business. It is known as ROE.
The calculation is as follows: Total Assets – (Total Liabilities, Goodwill, Trademarks, other non-tangible assets) / normalized net income = Return on net Tangible Assets. Goal is to shoot for 20%. In other words, it is a return on equity net of intangible assets or ROE.
I have mentioned in the past about the need to properly depreciate the rental fleet. My goal is to produce a net book value of the fleet at OLV (orderly liquidation value). If you write it down to zero book value, you have overstated expense as well as undervalues your fleet asset. For this calculation I would make the adjustments to adjust fleet value to no less than OLV.
ROE combines brand impact, capital efficiency and quality of earnings and considers the results from the prior 3 tests. It also rewards companies that can borrow most of the capital they need. For a dealer, that is important.
To summarize:
Cash Operating Profit should be 20% or more
No more than 50% of Cash Operating Profit used for Cap-X
Return on Invested Capital should be at least 20%
Return on Net Tangible Assets should be at least 20%
Hit most of these goals and you have an above average company when compared to other industries. You can also use your normalized EBITDA number to compare to other industries as well.
So, how do you think your industry fared in terms of these financial metrics? Great? Average? Or Poor?
To get an answer to the question I reviewed the latest MHEDA DiSC report and find that the TOP 25% QUARTILE can meet or get close to the minimum percentages required for each metric.
Surprised? I was to some extent. On the other hand, seeing that the industry can produce great companies only supports my belief that the management in your industry is above average as well.
You may want to calculate these percentages on an annual basis. You can submit your data for the DiSC report and ask your accountant to run these after they finish up the annual report. There is no doubt that meeting these goals would help “sell” the company when that time comes. When you can state that your company is a “GREAT “performer compared to all industry groups, you now have the data to back that claim up.
FYI, I saw these four metrics in a Stansberry Digest article. The Stansberry Digest is a great investment digital publication that offers both training and investment programs. It would be a great present for the next generation in terms of learning how to invest, but also how to manage the results in your company. I send numerous articles from the publication to my grandkids.
Garry Bartecki is a CPA MBA with GB Financial Services LLC. E-mail [email protected] to contact Garry.
