Since 2005, I have been doing reporting and analysis on company and sector inventory levels based on the annual Working Capital scorecard that is compiled by REL, a division of the The Hackett Group.
It is always one of our most popular columns of the year.
Once again this year, REL has been kind enough to send me the data set for some further analysis. The just released 2015 data is based on year-end 2014 financials from some 1000 US public companies.
It is great stuff, but the big value-add SCDigest performs here is to re-sort individual companies into new categories, so the categories and comparisons in our view are more usable for supply chain thinking. For example, in the original REL data, home builders like Toll Brothers are mixed in the household durables category with companies like Whirlpool. That may have been the most "apples and oranges" combination, but there were a number of others that don;t jive, at least from a supply chain perspective. Metal producers such as US Steel were in the same category as miners, in another example.
So, we do the (really) hard work of first eliminating sectors that aren't useful for the supply chain (e.g., bankers, etc.), and then redefining and populating the categories in a way that makes more sense for comparisons. As another example, rather than having one giant category of all specialty retail, we break that down into apparel, department stores, auto parts, etc. It really does take a lot of time.
It is far from perfect. Should Johnson & Johnson be placed in the pharma group, the medical device category, or consumer packaged goods, as it is in all those segments? Is Honeywell in the aerospace or automotive sector, or one of the few "industrial conglomerates" like GE or 3M? That's where we put it again this year. There are many such examples where the call is not obvious.
In the end, we simply made choices, including looking up more details on a number of companies with which we were not familiar, even though we look up many.
The full report and data set looks at three components working capital, changes in which of course directly determine overall cash flow: Days Sales Outstanding (DSO), Days Inventory Outstanding (DIO), and Days Payables Outstanding (DPO). Here, we are going to focus on just the inventory component.
DIO means how many days of sales a company is holding in inventory, and which REL defines as:
End of Year Inventory Level/[total revenue/365]
So, you calculate the average revenue for one day, and then see how many of those sales days you keep in inventory (based on year end balance sheet numbers).
As always, I want to make clear this is the definition that REL uses in its data set. Every year, someone writes in telling me DIO should be calculated differently, and my response is that this is the way REL calculates DIO, so that is what I must therefore use (and I think it is right anyway). Also, REL must use DIO, not inventory turns, so it is compatible with the other two components of working capitol, Days Sales Outstanding (receivables) and Days Payables Outstanding. The main working capital formula wouldn't work with a turns number.
As such, DIO is sort of the reverse of inventory turns, in that a higher DIO, all things being equal, means poorer inventory management performance, while a lower number signals improvement. You are being more efficient with inventory versus a given level of sales.
So, let's take an example. Retailer Costco had about $112.64 billion in sales in 2014. Divided by 365 days in a year, that means the company sold about $308.6 million worth of stuff every day. It also ended the year with $8.45 billion in inventory. So dividing that inventory number by the $308.6 million in sales per day means Costco held on average inventory equal to about 27.4 days of its sales. Apple, by contrast, manages to hold just about 6 sales sales days worth of inventory, though that figure is helped by its iTunes sales that I assume have no inventory at all. Construction and farm equipment company John Deere held about 62 sales days worth of inventory last year.
In case you were curious, Costco's 27.4 days of DIO could be compared to its inventory turns level of 11.6 (cost of goods sold divided by its inventory level). But by no means can we say that every company with DIO of 27.4 has an inventory turn of 11.6. The margins/cost of goods sold vary by company, making that linkage impossible, unfortunately.
In the overall US economy, inventory levels have remain relatively flat or even headed up a bit since about 2005, when compared to sales. As seen in the chart below, the "inventory to sales" ratio did spike in late 2008/early 2009 as the recession caught companies with way more inventory than needed versus suddenly shrinking demand, but they then chopped away at that inventory ruthlessly, so that it was back on the longer term trend line by early 2010. However, according to this government data, inventory levels have actually been trending slightly up in recent periods, probably as top line growth becomes more and more the priority (note: this is a monthly measure, which is why it is greater than 1 - inventory/monthly sales).
It has been slightly ticking down over the last few months. Numbers are very similar across sectors: manufacturers: 1.31 in May; retailers excluding autos: 1.29; wholesalers: 1.19. But all told, inventory performance has gotten worse since 2005 - interesting.
Now, back to the REL data.
Across all 1000 companies, REL finds DIO is down 0.2% year over year, down 0 .7% since 2010, and down about 2% since 2004. Across all 1000, DIO in 2014 was 43.1. However, among the 574 product companies from the list SCDigest analyzed, average DIO was much higher, at 77 days, but down 1% or so from 2013.
One thing that is really striking in doing this work across years is seeing how concentrated so many US business sectors have become. Office products retailers? We're went down to two a couple of years ago, after Office Depot swallowed OfficeMax. Next year it will be one, after Staples finishes acquiring Office Depot. Molson Coors stands alone in the Beverages - Beer category, the only public US brewer left. Next year, giants Kraft Foods and Heinz will leave the Food Manufacturers list, both acquired by the same private equity firm. Consolidation a megatrend.
all that doesn't leave me much room here. Next week, I will publish the full analysis across about 65 sectors. Below, some highlights:
Top 5 lowest DIO sectors: (1) Retail Convenience Stores: 8.4; (2) Restaurants: 12.6, and which would be number 1 if not for Starbucks (I think its coffee making side is the cause); (3) Business Furniture (19.3); (4) Retail Grocery: 30.1; and (5) Printing: 30.2
Top 5 highest: (1) Spirits: 287.6; (2) Retail Auto Parts: 208.9; (3)
Pharma: 177; (4) Biotech: 161.2; (5) Life Sciences Equipment: 151.1
Other notable sectors:
Chemicals and Gases: 76.8
Apparel and Shoe Manufacturing: 112.2
Mass Merchants and Dept. Stores: 78.6
Consumer Packaged Goods: 64.6
Computers and Peripherals: 41.7
I'll save the rest for next week, including what sectors have had the best improvement. Good stuff. Woild love your thoughts.
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