U.S. corporate bankruptcies year to date are at their highest level since the immediate aftermath of the Great Recession in 2010; banks are tightening credit in the wake of the acute stress in the regional banking system; and small companies in particular are reporting difficulty obtaining credit.
U.S. consumers are under acute pressure as well, with credit card debt at all-time highs despite interest rates of 20% and higher and all manner of consumer packaged goods companies and retailers reporting increased sensitivity to higher prices, trade-down behavior and shrinking sales of big-ticket discretionary items.
What will happen to U.S. consumers when borrowers have to restart paying their federal student loan bills in October? There also are other major risk factors beneath the surface, one of which is a form of hidden debt that U.S. corporations have made use of in recent years.
FreightWaves recently published an analysis of the usage of supply chain financing (SCF) among S&P 500 companies following recently required disclosures. Our estimate is that over $100 billion of this type of financing is being used by S&P 500 companies, and that the number is even larger when including non-S&P 500 companies — we estimate its usage in corporate America approaches $150 billion.
Why is this issue important to investors and the economy? SCF is essentially a form of short-term debt that’s not classified as such, and there are two risks associated with its usage: Its cost has increased dramatically as the Federal Reserve has raised interest rates by 500 basis points since March 2022 (with more rate hikes likely to come), and its continued availability is far from assured given increased stresses on U.S. banks coupled with the fact that SCF is an uncommitted line of credit from banks (meaning banks can withdraw the financing at any time).
If this form of financing becomes prohibitively expensive or unavailable, companies will be forced to find an alternate source of liquidity (most likely drawing on their revolving lines of credit with banks along with using any excess cash they have on hand) and in some cases could have difficulty doing so considering that SCF could be withdrawn amid an environment of rising banking and economic pain (at the worst possible time, in other words).
Our previous analysis prompted the question of what impact the usage of SCF has had on the time it’s taking companies to pay their suppliers, specifically what has happened to the days payable outstanding (DPO) of the 86 S&P 500 companies that use SCF (with more to come as some S&P 500 companies have yet to be required to publish such disclosures).
Not surprisingly given their heavy SCF usage, these companies’ DPO number has risen substantially in recent years, from an average of 71 days in 2016 to 91 days in 2022 (roughly a 30% increase in just six years). One might assume that these companies’ days sales outstanding (DSO) would have risen for the same reason that their DPO rose (companies are taking far longer to pay their suppliers), but that’s not at all what happened: The DSO figure was essentially flat while DPO increased 20 days (~30%). Why? Two reasons: the nature of SCF transactions and companies’ use of accounts receivable factoring/securitization.
Per the terms of SCF transactions, while buyers take longer to pay their suppliers, a bank or some other financial intermediary pays the supplier well in advance of the due date, less an interest charge (the interest rate on the amount outstanding), and the buyer pays the bank/financial intermediary thereafter in 120 days or whatever the agreed upon terms are.
Consequently, buyers’ DPO rise while the suppliers’ DSO don’t. Of course, there’s a price to be paid for suppliers getting paid more quickly than would have otherwise been the case, and that price is interest costs (banks are in effect lending to the suppliers). That price has gone way up over the past year as interest rates have done the same. In other words, these transactions have become far less financially attractive.
Regarding the other reason why companies’ DSO haven’t increased even though their DPO have, many have made extensive use of yet another financing tool, this one called accounts receivable factoring/securitization.
Factoring involves selling receivables to a bank or other financial institution (assuming the buyer of the receivables has no recourse; in nonrecourse factoring, there is a true sale of a trade receivable by the supplier), which has the effect of enabling companies to collect cash more quickly and getting the accounts receivable off their balance sheets.
Receivables securitization is the same general idea as factoring, but with some technical differences. And receivable factoring/securitization is the same concept as SCF (which is also known as reverse factoring); they’re both financing tools that make companies’ free cash flow look better than they otherwise would be, but at a cost, and that cost has risen to a significant degree over the past year.
Beyond the eye-opening differences between the recent trends in DPO and DSO, the trends by industry/sector are also illuminating. Relative to the overall increase in DPO from 2016 to 2022 of 20 days, the increases in communication services (mainly telecom companies) and consumer staples were particularly pronounced: Communication services’ DPO were up 44 and consumer staples’ DPO were up 31.
Coca-Cola is illustrative of what’s happened among staples companies over the past several years: Coke went from paying its suppliers in about 60 days in 2016 to paying in about 110 days in 2022.
While staples companies are taking more than 30 days longer to pay, they’re taking no longer to collect. Their DSO was flat over the past six years.
The most eye-opening DPO and DSO data pertained to the auto parts retailers O’Reilly Automotive, AutoZone, Genuine Parts and Advance Auto Parts. Their DPO numbers are by far the highest of any subsector we looked at, at an average of 260 days — in other words, they take 260 days to pay their suppliers. Meanwhile, they collect from their customers (their DSO) in just 20 days, which makes sense because they’re retailers (the majority of their sales are to consumers rather than to other businesses, because of which they collect more quickly than most other types of businesses).
Despite this pronounced asset-liability mismatch (which ought to be a major advantage), one of these companies is under obvious pressure; as we noted in a previous article on SCF, Advance Auto Parts just slashed its quarterly dividend by over 80%.
Lest the reader think that any concerns about cash flow/liquidity are overblown, the recently published Q2 CFO survey conducted by Duke University and the Federal Reserve Banks of Richmond, Virginia, and Atlanta from May 24 to June 9 suggests otherwise. The authors wrote that “rising interest rates and stress in the banking sector have created a tighter financing environment for all firms,” particularly small ones; that “small firm optimism about the U.S. economy is low and falling”; and indicated that liquidity/cash flow was among CFOs’ most rapidly increasing concerns. (Liquidity/cash flow wasn’t mentioned as a concern in Q1 but was among the top 10 concerns in Q2.)