CAM Construction Roundtable Recap: The New Recession Handbook
By DENNIS BURCK
With economic indicators pointing toward a recession, contractors need to revise their business playbooks to remain cost-effective and competitive in the 2023 economy. The short-term outlook appears to be challenging — inflation is persisting and raised interest rates have not quelled the trend. However, understanding what makes this recession different will be the key to surviving and thriving in the 2023 economy and beyond.
Joining CAM for the latest Construction Industry Roundtable on October 12th was a panel of experts well-versed in the construction economy with Alex Calderone of Calderone Advisory Group, David Sowerby of Ancora, and Shawn Spencer of Cogent Advisors. The event was moderated by Matt Gurwin of Doeren Mayhew.
“From a CAM standpoint, we listen to your concerns, write them down, and try to develop programming that can address them for the next six months to a year. We are excited to have all of you in the room today,” said CAM President Kevin Koehler, as he welcomed everyone to the morning event.
The event was generously sponsored by Doeren Mayhew.
A New Recession
Ancora CFA David Sowerby is a veteran economist and advisor, holding executive positions at Loomis, Sayles & Company as well as the Beacon Investment Management Company. Lending his voice to WWJ, WJR, Bloomberg and CNBC, Sowerby is a trusted advisor and economist in Michigan and beyond.
Sowerby pulled no punches when it comes to the state of the economy heading into 2023.
“It’s obvious we have a bear stock market. The average stock is 33 percent down from a 52-week high. That certainly invites the recession talk,” Sowerby said. “As far as ‘yes’ or ‘no’ for a recession? A recession is never a binary event. For what it’s worth, talking about southeast Michigan, at least what I watch is considered a recession.”
Citing an inverted yield curve and inflation-adjusted money growth going negative, Sowerby emphasized that the operative term for the future heading into 2023 would be a “mild” recession.
“The Fed [Federal Reserve System] missed this horribly. They are embarrassed right now. They created this incredible sugar buzz by throwing in fiscal stimulus, and now we are paying for it with higher inflation.”
However, the new recession will likely not be as serious in Michigan compared to the financial crisis of 2008, Sowerby said. “If you step back and think about Michigan today, there are a few factors that really play to our benefit. The cost of doing business here is a lot better than it used to be.”
Michigan’s tax system ranks 12th overall according to the 2022 State Business Tax Climate Index. Also, rising profit margins show that the automotive industry is in much better shape than in 2009 when GM and Chrysler filed for Chapter 11 bankruptcy.
“When you look at something as simple as net cash, GM and Ford are going to generate $10 billion in net cash this year each. If you look at past recessions, it was nowhere near that in terms of the cash they deliver. The auto industry to the extent we are tied directly or indirectly to may be in the best position in the last 40 years.”
Michigan also leads the country as an emerging market for “onshoring” or “reshoring,” both referring to the practice of transferring a business operation that was moved overseas back to the country from which it was originally relocated, Sowerby explained.
Most recently, Gov. Gretchen Whitmer used the term in June when American Recreational Products and Rexair announced expansion plans in Michigan, transferring production lines back to the state. GM’s $4 billion investment in the Ultium Battery Cell Plant in Lansing was also deemed an onshoring success story by The New York Times.
“The valuations are still pretty compelling here. It was going on five to six before COVID-19, and I think it is not going to slow down,” Sowerby said. “When you look at the number of company announcements where they are rebuilding or expanding here — Capex [capital expenditure] is growing as fast as I saw it in the last 15 years. It should be good for the construction industry.”
Recession Resistance in the Construction Industry
Advising distressed companies, the president of Calderone Advisory Group Alexander Calderone saw success and horror stories in the construction industry. “I worked in 2010 in the aftermath of the auto bankruptcies with one of the large contractors who built all the paint finishing shops for them. This was at a time when capital spending really stopped. It didn’t slow down. It literally froze,” Calderone said.
More recently, Calderone advised an organization that bought five mill-working businesses and was exposed heavily to the whirlwind of COVID-19 on the supply chain. “The business liquidated for 10 cents on the dollar.”
For the new recession, Calderone said contractors should be aware of three things that will most likely kill a business: cancellations, delays, and bad jobs. “The latter is the one we can most control.”
Heightened inflation will likely persist into 2023 and play a huge factor in what makes a job worthwhile, Calderone said. “In today’s environment, the Fed will have to choose between inflation and deflation. I think there will be a lot of pressure on the Fed to capitulate. I don’t think that looks like zero, but it could mean not going up to 10 or 12 percent. If the central banks have to decide the lesser of two evils, I think they will err on the side of more inflation versus less.”
The danger will be most prominent for those operating at a 5-10 percent net margin with a forecasted 2023 inflation rate of 4 percent, Calderone added. “If that is the case, it is time to watch your contracts. GMP [guaranteed maximum price] contracts in this environment are extremely dangerous. There are geopolitical risks disrupting the supply chains, and on top of that is the risk of general inflation. I would try to stay away from fixed fees and GMPs since these eliminate your ability to react to inflation and supply chain risk.”
Being proactive in integrating variable-cost infrastructure into a company helps it maintain viability in volatile market situations, Calderone explained. “In this business, if you wait for the margin erosion to react, it is really challenging to get that back. The guys I have seen be most successful aren’t the ones enamored with self-performing the most work that they can. It is the folks that build relationships, a strong system of subs, and can buy out jobs profitably without carrying a bunch of costs.”
Objective Data and Self Discipline Keep Businesses Afloat
Building a company culture of transparent accountability is the first step in creating business data and using it to your advantage, Cogent Advisors CEO and co-founder Sean Spencer said. Founded in 2022, Cogent Advisors helps organizations improve their current and future enterprise value. Prior to Cogent, Spencer served as CEO of Toebe Construction and COO of American Fence & Supply Co.
“You need to have metrics based on what you’ve done successfully in the past, not what your neighbor has done or your friend has done,” Spencer said. “Look at what you did really well. Do it with your team as a collaborative experience. Go around the room and talk about all the positive characteristics of a job, then come back to those exact same jobs and talk about the negatives. And don’t just do this with the ivory tower people -- you have to include supervisors, superintendents, and foremen. It is imperative that you have info from all aspects of your business.”
Having this data helps keep the company insulated from “emotional bidding,” or bidding a job without metrics in place to judge success. “With this system, you have to have a leadership team in an organization not make emotional bids. Now you can come back to those ratios based on objective facts,” Spencer said.
But the process doesn’t stop just at the job site.
“The next step is to look at the finance people: Look at how you bid it versus how you actually performed on it to determine your company’s success rate. It is important because now you will have an objective model to use when working with estimators instead of an emotional one. I see numerous owners not doing this regardless of heavy civil or trades.”
Objective data and success ratios at job cost meetings will be invaluable to pursuing smart contract work in 2023 and beyond, Spencer added.
Old Adage Holds True in 2023
“Follow the money” is a saying across many industries, but it is a saying definitely worth taking seriously under the tightening conditions of a recession.
“We are telling our clients to follow the dollars,” Calderone said. “There is still a lot of gas left in the tank, and I think it is going to trickle down to infrastructure. The shift to electric vehicles… I tell anyone who touches automotive that the Capex dollars should be there.”
The most recent AIA Construction Consensus Forecast shows a 9.9 percent increase in industrial construction. “I think that is a function of onshoring and automotive industry electrification initiatives,” Calderone added.
“The [automotive] lineup is stronger. The patents with electric vehicles and autonomous vehicles are better. Profitability and break-even levels are 50 percent better than they were from 1990 to 2007,” Sowerby added.
With help from state Strategic Outreach and Attraction Reserve (SOAR) funding, Michigan announced the new construction of five battery plants valued at $8.2 billion within the last year across the state.
“You need to be paying attention to the macroeconomic situation and where the government goes with its money. Chasing the government's money is never a bad strategy,” Calderone said.
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