Companies cut back to produce future growth, just like the vineyards

Schalk Louw of Contego Securities writes that during a recession, companies have to be pruned, or cut back, just like the vineyards

Spring is in the air, and even though it is hard to believe that winter is over if you look out of the window, another of the four seasons of this year has nevertheless gone by. Nowhere else is this more clearly visible than in the beautiful Western Cape vineyards. Seeing that mountain bike events such as the Karoo to Coast, DCM Cape Pioneer and Contego Wines2Whales are just around the corner, I wiped the dust off my bike about two months ago and started training.

It seemed almost incredible how the vineyards were literally pruned back so that only the root-stock was left, and it was hard to imagine that any future life remained in those vineyards.

It was not long before I found out that vineyards do not die if they are pruned. On the contrary, pruning the vineyards actually helps improve the quality of the harvest. The vines must be cut back so that sufficient light can reach the branches and it also makes the cultivation of vineyards easier. Last week when I went cycling again, it was astounding to see how beautifully the vineyards were sprouting to a luscious green. This reminded me of the present markets.

Up to and including the end of 2007, we experienced the most incredible “investment summer” worldwide. Although this was a wonderful time for most, neither companies nor individuals really curbed their spending or hesitated to make debts. If we consider six of the world’s biggest retail companies (i.e. Coca Cola, Colgate-Palmolive, Kimberly-Clark, Pepsico Inc., Proctor & Gamble and Walmart Stores), we will note, in the first place, that these companies collectively showed sales of $154,8 bn. (nearly 2,5 times the turnover of South Africa’s full GDP) at the end of term in June 2010.

These figures not only assisted in bringing these companies’ sales to nearly 12% more than last year in June, but also helped these retail companies increase their profits above consensus expectations.

It is hard to believe that there are still managers, strategists or investors who look at these figures and feel that a double dip recession is becoming a greater possibility. Why?

Well, if a closer look is taken at these figures, it is evident that this quarterly turnover of $154,8 bn. is still lower that the sales of the last quarter in 2007 ($156,3 bn.), i.e. consumers are, despite a much, much lower interest rate milieu, still spending relatively less than at the end of 2007. Does this, however, give investors a reason to sell out their shares as at the end of August? In my opinion, the answer is no.

The reason for this is that companies worldwide, just like the farmers trimming their vineyards, have also been cutting their expenses “back to root-stock” since the recession of 2008. Although these retail companies’ sales are at present just a tad lower than at the end of 2007, their expenses are also lower ($101,6 bn. for the present, versus $104,5 bn. at the end of 2007) – on the contrary, this is however proportionately quite a lot less than the decrease in sales. This was in effect not favourable for the unemployment figures, but with all the cost cutting and laying off, companies world-wide is now for the first time in nearly a decade offering more value.

Take care, therefore, not be carried away by die roaring bears. Not everything is necessarily rose-hued, but the “branches” have surely not died and are already, slowly but surely, starting to sprout!