January/February 2012

Sectors Offer a Mixed Bag of Opportunity

To launch the new year, we asked Rosenthal & Rosenthal’s James Occhiogrosso to take a look at borrower sectors that rely on factoring and asset-based financing in this, ABF Journal’s first ever Specialty Lending Forecast. While certain sectors offer opportunity, all require diligence and in some cases, patience.

Although the American economy, as with the economies of other nations, is down over the past several years, the commercial finance sector has seen ample opportunities to make deals and transactions because banks, private equity and capital concerns have not been as aggressive in these market conditions. Although 2012 may offer more of the same, but these mainstream traditional sources of funding appear to be coming back into the market. That being said, the non-bank commercial finance sector, factors and asset-based lenders, will still have a fair share of the market in the coming year.

Continuing the trend of the last several years, American wholesalers have been drawing down more from their warehoused goods to meet, what appears to have been, a slight rise in demand and sales. This is symptomatic of the overall improved efficiencies by many businesses in the management of inventory. Sales appeared to have stayed consistent, perhaps even with slight improvement through the end of 2011. So there should be a resulting ramp-up of production in the first half of 2012.

Automotive: There has been some increased stability exhibited by the car manufacturers in more volume of cars produced and the hiring of employees. The ancillary parts vendors also are doing well. This sector is seeing even greater activity because vehicle owners now keep their cars and trucks longer. This extended life cycle greatly benefits suppliers and service businesses (i.e., brakes, transmissions, mufflers).

The Japan disaster of nearly a year ago has clearly slowed the supply chain for certain new and replacement automotive products, so there’s a scramble for alternative sources. Overall, I would continue to welcome ABL and factoring opportunities in this sector going forward.

Jewelry: As 2011 closed, both the high-end and low-end retailers and respective manufacturers appear to be doing well. There is improvement at the high end where wealthy and affluent customers are returning to the luxury and designer markets. The middle-market has all but disappeared.

The lower end has done well as manufacturers are offering more perceived value by putting diamonds and colored stones on silver instead of gold. Gold is so expensive now that it is really not used in mainstream jewelry other than as an accent. There is a continuing trend at the low end with the use of alternatives like titanium and industrial metals, often marketed and sold using brand names and themes. The jewelry sector is becoming more Internet and non-traditional outlet driven, with Amazon, the warehouse clubs and home shopping networks all gaining market share. Jewelry counters at department stores appear to be stable.

To compete, the independent small retail store needs to sell high-end or unique, specialty jewelry that has limited availability and provide a high level of service. Generally, many factors and ABLs avoid the jewelry sector, but for those that are in it, 2012 appears to offer some opportunities on either side of the spectrum.

Apparel: Brand name manufacturers, suppliers and distributors were okay in 2011 and are optimistic about some improvement in 2012. If they survived the past several tough years and continue to market their brand and source it properly, 2012 offers good potential. Again, the Internet has had some game-changing effects on pricing and sales because of the ease of comparison shopping. This has had less impact on the designer brand names than on the generic or house brands of the retailers. The apparel sector continues to be a traditional source of transactions for factors and ABLs.

Footwear: More specialty retailing outlets have opened as evidenced by stand-alone Marshall’s shoe stores and big name retailers carving out space for larger and larger shoe departments. Federated recently announced the creation of “the world’s largest shoe store” for its flagship Macy’s store in Manhattan. Recession, or no recession, women’s shoes are a staple and a feel-good purchase. Commercial finance companies will continue to support this market but will need to be vigilant with the inventory piece of the funding.

Furniture: Suppliers, distributors, wholesalers and importers on the soft goods side of the industry, everything from drapes to fabrics to bedding, seem to have held up in 2011, and are looking for more growth in 2012. Most of these developments appear to be low- to mid-end. Bedding is emerging as especially profitable with a lot of positive results for the purveyors of these goods. Designer name products that are mass market priced appear to be the way to succeed in this segment. It’s another area of opportunity for factors and ABLs.

Electronics: With respect to commercial, defense, and government procurement electronics, this sector is performing decently and may pick up even more in 2012. One concern is the rapid innovation in the industry and the resulting shorter product life cycle. A commercial finance firm does not want to get stuck with last year’s technology. We look forward to supporting many businesses here that are ramping up for the LED lighting conversion, which will be huge. This technology shift should occupy a number of businesses producing and servicing this sector for the foreseeable future. It offers decent prospects for factors and ABLs.

Appliances: People are freshening up their houses either for re-sale or because they don’t want to upgrade to a new home — the area with the biggest payback is the kitchen. Appliance replacement is therefore booming. Most retailers are offering aggressive pricing, incentives, discounts and rebates. As an ABL or factor dealing with this industry, you need to be cognizant of the potential dilution to your receivables and inventory valuation.

Call Centers: Some of this business is starting to return to the United States, so financing opportunities may become more available. These are usually strong receivables, especially if they’re from the phone and cable operators and similar major companies. There is also an opportunity on the service side implementing new software packages, servers and systems. ABLs and factors must be aware of the progress billing issues associated with these larger and longer-term installations.

Transportation: One sector that continues to thrive is the limousine or “black car” business as most of the receivables are paid by large corporations, professional firms and the like. Sales were negatively impacted by the recession but have rebounded nicely. Most companies weathered the downturn fairly well as expenses are usually positively correlated to sales. Similarly, the private airplane aviation industry has solid receivables for the same reasons, even though revenues are stagnant here and may not show much improvement in 2012.

Logistics: Shipping and storage companies are thriving, especially where businesses have outlasted some of their competitors. Shipping is not up to any great degree, but the survivors are increasing volume because of vacated business. Depending on the client base and resulting receivable quality, these can be extremely good clients for ABLs and factors.

Food Service: While there is enormous price pressure from competitors and cost pressure from the underlying agricultural commodities, the sector is doing fairly well. Perhaps, because of these pressures and recent increased regulatory oversight, it seems many banks have shed the smaller, independent family-driven business accounts or pared down their exposure. There’s value and resulting business being created through famous chefs putting their name on products, improved packaging technology, television marketing, brand website selling, and more. Especially for ABLs, this sector offers good potential this year.

Publishing/Printing: Everyone is learning how to do business with new Web-based models that should continue into 2012. The technology revolution here has meant a huge shakeout where it is no longer attractive to have any meaningful ABL or factoring activity on the old-school traditional operations. This year, expect to see continuation of businesses re-directing into digital, Internet publishing and printing with hi-tech, computerized graphics. There are still businesses that are thriving with traditional methods but financing them requires careful study and diligence.

Office Supplies: This sector looks to be pretty stable going forward. More than ever, this is Internet-driven, with extraordinary price pressure and very little brand loyalty from customers. Almost all of this product is manufactured overseas, so opportunities here come from wholesalers, suppliers, distributors, importers and the like. These transactions usually require a heavy reliance on inventories by the lender.

Pet Supplies: This is a relatively untapped market for factoring and ABL. It continues to look solid for 2012. There is much in the way of products here beyond cats and dogs — everything from fish and reptiles to livestock. Patience and time is required because a lot of this space consists of small family enterprises and entrepreneurs, many of which are product-driven and not business executives knowledgeable about finance. Transaction size tends to be smaller, owing to the nature of the potential borrowers.

Toys: Sales appear to be static and this can be a tough sector for many ABLs and factors. If you are working with a hot, popular item, it can represent a good opportunity for lenders — for example video games, software but not hardware. These games have been doing well the last couple of years.

However, the lender must be aware of the risk that the next new popular game makes the last one obsolete. In traditional toys, retailers are becoming much more demanding on holding back money for returns, breakage, the right to back out of commitments on inventory orders, etc. While I will always look at a deal here, it is not my favorite sector.

There’s a dichotomy moving into 2012 where the Consumer Confidence Index is down — but consumer spending has stayed steady to trending slightly up. While I believe uncertainty will continue to define the business environment for 2012, I am optimistic that we will continue to see interesting lending opportunities. The November 2012 elections hopefully will remove some of that uncertainty but we will have to wait and see their effect.

James J. Occhiogrosso is an executive vice president and the head of asset-based lending at Rosenthal & Rosenthal, Inc., a privately held factoring and finance company now celebrating its 73rd year. Recently named by Crains as one of the top ten privately held businesses in New York, Rosenthal provides factoring, asset-based lending and specialty lending to clients across a wide range of industries. The firm has its primary offices in New York, Los Angeles and Shanghai.