THOUGH positives have started to emerge in the market, harsh realities such as austerity measures and continuing downsizing linger and it is not surprising that consumers have prioritised and have slashed spending accordingly. This means challenging times ahead for companies that trade in non-essential consumer products. The impact of the global recession continues to be felt in Jamaica, and companies such as Caribbean Cement Company Ltd (CCC), Desnoes & Geddes Ltd (DG), Seprod Ltd (SEP) and GraceKennedy Ltd (GK) have reported lower earnings for the first quarter of 2010.

One industry that has been adversely affected by this reallocation of scarce consumer resources is the construction industry. For the fiscal year 2008/09 and 2009/10, the Planning Institute of Jamaica (PIOJ) reports that the construction sector declined by 7.9 per cent and four per cent respectively. As expected the amount of inputs demanded by this industry declined. For example, the amount of cement sold to the local market by CCC in 2009 declined by 9.38 per cent moving to 652,651 tonnes down from 720,260 tonnes in 2008. For the first quarter of 2010, CCC sold 157,649 tonnes down from 177,689 or 11.2 per cent when compared to the same period last year.

The recent environment is also challenging for Hardware & Lumber Ltd (HL) which has been battling a number of external and internal factors. One of the chief external factors is reduced demand for the Company’s products during this recessionary period. The Company’s core business focuses heavily on retailing and wholesaling building materials, home improvement supplies, household items and agricultural products. As the housing market and construction industry contracted, so did the sales at the Company. Sales declined by 12.5 per cent in 2009 as people halted new construction and planned home improvements as they watched the value of their financial portfolio decline and risk aversion ruled.

The correlation between HL’s sales and the economy has continued into 2010, at least for the first quarter ended March 31, 2010 (Q01 2010) when compared to last year. The construction industry declined by 3 per cent and HL’s revenues declined by 5 per cent, moving to $1.44 billion down from $1.5 billion for the same period last year. Interestingly the last time the Company posted a profit was in 2007, when the construction industry grew by 4.3 per cent. In 2008 and 2009 the construction industry declined by 5.2 per cent and 4.5 per cent respectively and HL posted losses in both those years.

The relationship between the Company’s revenue and the economy is reinforced even at the segment level. For Q01 2010, the only segment which posted a profit for HL was the agricultural segment, which recorded a 4.5 per cent increase in revenue in the quarter as compared to 2009. For the economy, the only sector in the Goods Producing category to register an improvement was agriculture. Agriculture improved by 2.5 per cent while mining, manufacturing and construction declined by 40 per cent, 2.3 per cent and 3 percent respectively.

Internationally, when we examine peer Companies to HL such as Lowe’s Companies Inc (NYSE: LOW) and The Home Depot Inc (NYSE: HD) their fortunes are also intricately linked to the performance of the overall economy and the construction industry. Their sales and profits correspond to housing starts and the capricious change in consumer confidence. In 2009, LOW and HD sales declined by two per cent and seven per cent respectively, as housing starts fell by 39 per cent (www.census.gov) .

This external factor of reduced demand for HL’s products during this recessionary period will be quite a formidable obstacle to overcome. However, the Company has been addressing the factors that it has the ability to manage. Its focus on these internal factors has yielded some encouraging outcomes with its last two consecutive quarters showing improved results, but losses to shareholders.

For the three months ended March 31, 2010, revenues were $1.44 billion and net losses were $10 million compared to $1.5 billion and $113 million, respectively, for the comparative period in 2009. The significant improvement in the quarter’s results was due to the impact of cost savings, as well as reduced finance costs following a reduction in US dollar denominated debt.

In addressing the internal factors it can manage, HL has gone on a campaign of aggressive cost containment and reduction and efficiency improvement projects. It is expected that these projects will improve its financial performance in the coming quarters. Working capital management has also taken a greater priority as it looks beyond inventory management to improve collections and its overall cash position. In addition, HL is embarking on a plan to outsource its distribution function as a cost-saving measure. HL’s formula of reducing costs and debt, while improving its internal processes has definitely improved its bottom line.

The question shareholders are asking though is will this be sufficient to return the Company to profitability in the short-term and maximize shareholder value over the long-term?

HL must be pioneering and think outside the box in order to deliver to shareholders a business model that is not only sustainable but which can thrive in the exceedingly challenging Jamaican environment. Avenues such as reorganizing its branch network, as well as implementing new management structures which will minimize overhead and increase efficiencies will position the company to take advantage of untapped or emerging opportunities. These need to be explored and executed without increasing costs.

The internal factors which HL is working on are just half of the equation. The other half of the equation, the external factors, particularly consumer demand is hard to pin down. Improving customer service and refurbishing stores will only be effective if consumers walk into your stores in the first place. Consumers will continue to be cautious with their disposable income, and may continue to put that construction or home improvement project on hold, at least until the economy starts to indicate otherwise. While HL may become an efficient ship, it will still need improved consumer demand to be the wind in its sails to push it its desired return on equity to 20 per cent or higher.

Deon McLennon is an Investment Analyst at Stocks & Securities Ltd. You can contact him at dmclennon@sslinvest.com.