2009 Industry Outlook
The effects of the recession will be felt across the board, but healthcare will be one of the better performers this year
The director of the Selig Center for Economic Research at the University of Georgia’s Terry College of Business reports on some key Georgia industries and their prospects for the year ahead.
Decreases in international trade, decreases in industrial production and tightfisted consumers will cause total cargo volumes to decline in 2009. The biggest challenge will be substantial declines in both U.S. and state GDP, especially given that the declines will be focused on transportation-intensive sectors of the economy – such as housing and durable goods manufacturing.
The Georgia Ports Authority indicates that its number one priority is the Savannah Harbor Expansion Project. This project will consist primarily of harbor deepening and will constitute the largest civil works project in Savannah’s history. It is vital to complete this project before the Panama Canal expansion project is completed in 2012. Also on the fast-track are four “last-mile” projects dubbed “The Cargo Beltway” that must be completed to keep cargo moving along the last miles to and from the waterfront.
Due to the recession and the slow pace of economic recovery that will begin late in 2009, the balance of power will favor shippers over truckers. Declining volumes of truck freight in 2009, slow growth in freight traffic in 2010 and growing competition within the more profitable sectors will keep trucking firms from raising rates sufficiently to fully offset costs. Truckers’ net margins will erode. The recent flurry of mergers and acquisitions among these companies will help to slow the erosion of net margins, but even this favorable development will be offset somewhat by the much accelerated consolidation of retailing.
The good news: In Georgia, home price declines have been and will continue to be very modest in most neighborhoods. We aren’t seeing much of a correction, because there really is nothing to correct. We had a supply bubble, not a price bubble. The steep downturn in single-family home sales will bottom out by May. Declining new home construction will bottom out by July.
The not-so-good-news: Any realistic upturn in either home sales or homebuilding will pale in comparison to recent plunges in activity. For example, permits to build new homes have dropped about 75 percent since their peak in the first quarter of 2006. That’s a free fall. Georgia’s single-family housing starts are at the lowest level since the 1981 recession, when our population was about half of today’s nearly 10 million. So, relative to the size of the economy, today’s housing downturn really is much, much worse than that of 1981.
We will see upturns in home sales and new home construction, but we may not see existing home prices appreciate until mid-2010. The large inventory of unsold homes will keep a lid on prices.
Private spending for new nonresidential construction will decrease sharply in 2009 and moderately in 2010. The repricing of risk to more accurately match asset fundamentals will exert downward pressure on asset prices and constitutes a primary headwind, especially for markets such as Atlanta with high vacancy rates. By 2010, employment and population growth will begin to generate gains in net occupancy, but vacancy rates will remain elevated due to space in the development pipeline as well as sublease space that will continue to come onto the market. Tenants will have the upper hand in lease negotiations.
Compared to many major metropolitan areas, office rents in Atlanta are a bargain and will remain so for an extended period. That’s obviously a big problem for the owners of office buildings; it also should be a problem for investors and developers. However, it represents a good opportunity for the state to aggressively recruit new businesses to the Atlanta region.
The situation in Atlanta’s industrial property market is similar to that of its office markets. Net absorption turned negative and vacancy rates are high. An abundance of speculative construction took place in 2006-07, but new construction dropped sharply in 2008. There will be even less new construction in 2009-10. The ebbing of new construction reflects the repricing of real estate risk and pressures on development costs, as well as excessive supplies of ready-to-lease space. Better conditions for the industrial market may not appear until 2011, and the wait could be longer if speculative construction does not drop immediately.
Financial institutions will be challenged by many factors: low net interest margins, high mortgage default rates, the deep housing recession, less spending for expensive consumer durable goods, sharp declines in corporate profits and few opportunities to boost earnings derived from mergers and acquisitions, IPOs or trading stocks. Banks that cater to business customers are likely to fare slightly better than those that cater to households, reflecting better fundamentals for commercial and industrial lending than for consumer lending.
Poor conditions in state and national housing markets, less mortgage origination and refinancing, restraint in consumer spending for durables and low net interest margins will have the greatest impact on community banks. Financial institutions also will have to cope with slower growth of non-revolving loans to consumers, more identify theft, more concerns about privacy, persistent overcapacity and new regulations.
Property and Casualty Insurance
Heightened competition among insurers and a less than accommodating macroeconomic environment will further reduce insurers’ pricing power. Premiums will decline a third straight year for commodity-like insurance products. Consequently, property and casualty insurers will not earn underwriting profits on personal and commercial lines in 2009.
Insurers won’t be able to offset the loss of pricing power with gains in investment income. The shift toward lower returns on investments began in the second half of 2007 and will continue through 2009. Federal Reserve rate cuts significantly reduced yields on relatively risk-free types of long term bonds, which constitute the vast majority of insurers’ portfolios. Although rates on riskier categories of bonds rose, insurers did not benefit because they hold too many risky assets in their investment portfolios.
While the vast majority of insurance business is tied to renewals, there will be a slight decline in households’ demand for property and casualty insurance, which will further limit insurers’ profits.
The severe downturn in housing activity has eliminated the most powerful force behind growth in Georgia’s amount of insurable property. The recession and depreciation of home values will severely limit increases in insured amounts and may lead to reductions in insured amounts in some local markets. Also, as the proportion of households unable to make their mortgage payments rises, claim rates on home insurance policies will increase. Homeowners in a financial bind – especially those threatened with foreclosure – will be less able to maintain and otherwise secure their homes. Loss performance will deteriorate on foreclosed, vacant and neglected homes. Insurers should be prepared to devote substantially more financial resources toward detecting insurance fraud and settling claims.
The forecast calls for the percentage of the state’s lodging rooms that are rented to decrease substantially, but room rates are likely to be steady during peak periods. Peak room rates in many areas will remain at all-time record highs, but off-peak rates will be sharply lower. Lower demand for rooms plus the delivery of new hotel rooms already in the development pipeline will combine to drive down occupancy rates. The industry’s impressive performance over the last several years caused supply growth to accelerate, and it began to outpace demand growth in 2008. Unfortunately, in early 2009, the hospitality industry is probably only about one-third the way through the down cycle, which will extend through 2010.
Prospects are best for mid-priced properties without food and beverage operations. Corporate travel policies will favor such properties as they put greater emphasis on cost control. Until the economic situation improves, recent trends that favored higher quality and more sophisticated accommodations will reverse.
Expenditures for restaurant fare will decrease. Limiting factors include employment losses and declines in business activity, discretionary personal income and travel and tourism. A smaller proportion of guests are ordering alcoholic drinks – which can be a very important profit center – with their meals.
Fast-food and inexpensive quick-casual restaurants are expected to do better than moderately-priced restaurants or expensive full-service operations. Fast food restaurants are expected to partially recoup recent losses in market share to quick-causal restaurants, which will take market share from moderately-priced and full-service establishments.
Cable and Satellite TV
The lackluster outlook reflects a cyclical decrease in advertising outlays, a downswing in political advertising, slower growth in the demand for an expanding array of new digital products and other optional services and declining demand for basic services. The recession will cause subscriber churn rates to rise; and an increasing number of economically stressed households will disconnect premium services. Growing on demand content will help drive the industry’s overall revenue growth, however. Cable television also will benefit from the increased quality and affordability of digital cable-ready HDTV sets.
Advertising expenditures will contract sharply; a perennial threat to advertising revenue is the increasing popularity of devices that allow viewers to bypass commercials altogether. Rapid growth in the quality and quantity of online video content is a challenge for providers of cable television and satellite television.
A seemingly bottomless recession in homebuilding, less spending for residential renovations and a slump in commercial construction will be the main factors behind lower demand for lumber and wood products. Even demand for pallets and crates will soften with the decline in overall economic activity. Furniture sales to households will drop significantly in 2009.
Declining corporate profits and tight credit will limit the corporate sector’s ability and will to purchase more manufacturing equipment. When the Kia plant comes online in late 2009 or 2010 it will employ about 2,500 workers, replacing about half the jobs lost at the shuttered Ford and GM plants combined.
Accounting for about one fifth of Georgia’s manufacturing gross state product, food product manufacturing will maintain its presence in Georgia, both in terms of output and employment. Demand will grow at a very moderate pace. Georgia’s apparel manufacturing industry suffered some major setbacks in 2006-08, and it will continue to contract as open world trade and cheaper foreign labor give a tremendous price advantage to many imported items. The weak economy will ensure that the domestic industry’s sales and profit margins remain under severe pressure.
Georgia’s carpet and textile industry will be coping with the housing recession, less housing renovation, declining spending for nonresidential construction and slumping automobile sales. Demand for many chemical products will decrease in the typical cyclical fashion. The main problems facing chemical manufacturing will be the decline of the industrial sector of the economy, slumping sales for consumer use, less nonresidential construction, declining auto sales and the housing recession.
Printing and Publishing
Georgia’s printing industry faces more competition from other media and printers located abroad. Add an economic recession to these challenges and the result is a slump in both sales and profits in 2009. Declines in spending for advertising – especially political advertising – will be the most powerful headwind. Lower levels of office-based employment and less business formation will curb demand for printed materials.
Slumping revenue collections by state and local government will prevent public schools, colleges and libraries from increasing outlays for printed materials, despite higher enrollments. The more widespread use of electronic publishing will ensure that the industry’s revenues will drop even more rapidly, and high quality machines for small printing jobs will reduce organizations’ economic incentive to outsource small runs.
From peak to trough, Georgia’s total retail sales will drop by at least 10 percent, as recent and continuing job losses undermine consumers’ confidence and reduce their ability to spend. Households’ inflation-adjusted disposable personal income will continue to drop through the second quarter of 2009. With credit conditions still tight, reductions in buying power will cut deeply into households’ spending for all but the most essential items. The erosion of households’ net worth will prompt all but the super rich to pare back spending for retail goods.
Cyclical decreases in demand for legal services will hurt lawyers and law firms. Both the housing recession and declines in nonresidential construction will reduce the amount of money spent by businesses and households on legal fees. Firms that provide legal services to households rarely prosper when disposable personal income is dropping and job losses are mounting.
Firms providing services to businesses will feel the adverse effects of fewer business startups, fewer expansions and fewer mergers and acquisitions. Businesses typically devote fewer resources to litigation when corporate profits are on the downswing; but legal work related to company restructuring, insolvency, bankruptcy and intellectual property will be on the upswing. The Sarbanes-Oxley Act will continue to spur demand for legal services.
This sector will be one of the better performers in 2009, helped by Georgia’s rapid population growth, stable funding for Medicare, the new Medicare prescription drug insurance plan, more use of health services, better management of operating expenses and the increasing market power of healthcare providers. Large numbers of baby boomers are reaching the age where the incidence of heart attacks, strokes and other care-intensive problems begins to rise rapidly; the population of individuals with multiple chronic health conditions continues to grow regardless of the ups and downs of the business cycle.
One problem for healthcare providers is that heavy job losses will increase the proportion of customers who self-pay or do not have insurance. It will be harder to collect funds from self-pay and uninsured patients than from insured patients. Once labor market conditions improve, an increasing proportion of Georgians will be eligible for employer-provided health insurance plans, which will lower bad debt expenses.