Replacements

The FINANCIAL COUNSELOR

The Financial Counselor is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give personal advice, either in these columns or by letter

by JONATHAN C. ROYLE

WEAR and tear! Few think of wear and tear as a factor in profitable investment, yet it is one that will largely determine which industries will show the first betterment in business and which securities will record the earliest advances in market quotations. Replacement demand will give the first impetus to retail buying, which, after all, determines whether producers and distributors make profits.

For nearly three years retail buyers, like Achilles, have sulked in their tents. They have put off every conceivable purchase as long as it was humanly possible. They have made old goods and commodities do double and triple duty. They have patched and mended and repaired and contrived, with the result that old materials are now worn out and there has been built up a tremendous backlog of demand for replacements.

Before the buying power of this country is directed to supplying new needs, it must and will replace those necessities which have been worn out or destroyed during the period of buying inertia. And moth and rust have had ample opportunity to corrupt during the last three years. Those industries which are in a position to fill this replacement demand will be called upon, therefore, not only to supply current needs, but to fill the orders which, in normal times, would have been distributed over that entire period, and which were merely delayed and nol abandoned.

For purposes of illustration, let us attempt to gauge some of this piled-up demand. Wear and tear, erosion, rust, chemical action, and other agents are destroying steel as fast as it is now being produced. This means that there is a prospective demand which would keep all the mills in the country at work for a year at least, merely to replace the steel now in use.

The railroads of the country need 1,000,000 tons of steel rails. Whether they can and will buy them within the next year, they need them to put their lines in the same fine condition which characterized them in 1929. Replacement of existing pipe lines will account for a huge volume of tubular steel, to say nothing of requirements for new lines. Additional demands will come in a less imperative form from the manufacturers of agricultural implements, from users of wire and wire fencing, and makers of industrial machinery.

Although America has found that the life of a motor car is longer than anyone supposed, automobiles do wear out. In the last year more than 500,000 old cars were taken from the roads, or a little less than 50 per cent of the number of new cars sold. Few were sold for replacements, and those 500,000 cars will have to be replaced sooner or later. A reserve demand for cars is being piled up which will yield wonderful profits to the automobile manufacturers which are best prepared to meet it. This also will mean a gain in steel demand.

Building operations have been lagging since 1928. Few structures other than public buildings have been put up in the last year. Buildings wear out, become inadequate and obsolete. When business and employment revival comes, it will reveal a replacement demand for dwelling and office space which will require an expenditure of over two billion dollars to fill.

Who will benefit?

Producers of steel, lumber, cement, hardware, plumbing supplies, heating and refrigerating equipment, and building-material manufacturers in general. They will have a market for goods above and beyond the normal demand. There has accumulated a prospective call for small dwellings which will involve paying out $750,000,000 a year. The repair bill of the householders of the country normally amounts to $550,000,000 a year. It will require the spending of twice that sum to make up the work which has gone undone since 1930. When betterment starts, additions and improvements will call for an additional $100.000,000. Think what that will mean to lumber men and paint producers.

As to lumber, the railroads have 250,000 cars in need of repairs. This one item will call for the use of about 250,000,000 feet of lumber. The cement industry has a prospective demand for over 25,000,000 barrels for road work planned but still unexecuted.

Americans have been wearing their old clothes, but these will not last forever. The volume of woolen clothing needed is extraordinary, The demand for shoes is certain, especially since the majority of all the shoes sold are not of expensive, long-lasting grades, but such as are made to be sold at a price well under four dollars a pair. Improvement has already manifested itself in these textile and leather industries. Stockings, underwear, and other wearing apparel have piled up a backlog of demand on which manufacturers can count. There have been 2,500,000 fewer pairs of overalls and work shirts sold this year than last. When workers resume their jobs, this postponed buying will be translated into cash sales.

These items are mentioned merely as examples. Similar replacement demands can be foreseen in scores of other lines, such as house furnishings, floor coverings, business machines, and furniture. Even washing machines and radios do not last indefinitely; china, glassware, and pyrex dishes get broken, and the life of an aluminum saucepan or an iron skillet is not extensive.

It by no means follows that only those lines in which there is a heavy replacement demand will show profits or become advantageous investments. But it is certainly sound logic to attribute to them an advantage over those whose products are destroyed or changed in form at once and in which there are no back requirements to be filled, such as fuel oil, gasoline, coal, matches, tobacco, and food.

Any investor can pick, out of his own knowledge, the branches of industry which have a backlog of prospective sales for replacements. It does not follow that each business unit in these industries will profit or become a sound investment returning prompt dividends. Competition will be keen. Profit margins will be narrow. There will be few ' Johnny-jump-ups’ found in the list of commodity prices. Betterment in prices is to be expected, but it will be slow, and probably will not attain the heights of 1928 and 1929 within the lifetime of the present generation.

That means that any firm, to be successful, must be efficiently run and economically managed. It will certainly avail nothing to have a big demand unless orders can be filled at a profit. Advances in price, if too hurried, might well check buying and delay replacements still further. Production costs, therefore, must remain low if a firm is to be successful. This is not now to be regarded as a major obstacle. Modern equipment and efficient methods have already solved this problem for most producers.

The same dependence on volume that was so much in evidence before the depression does not exist to-day. Then the plant superintendent was the big figure, and the ability to turn out large numbers of units in each plant was deemed of first importance. Executives have learned that it does not profit them to be able to turn out thousands of units if they can only sell hundreds. Dependence on mass production is not out of the picture, but it is sharing the foreground with salesmanship. Only concerns which stress this end of the business should be accounted worthy of investment to-day. Another item which should not be overlooked by the investor in the securities of corporations with a replacement demand is the question of capitalization. Replacement demand is to some extent temporary; plant capacity and capitalization should not be expanded beyond a point that is justified by average demand.

If these considerations are kept in mind, the investor can he fairly sure that he will be in a position to profit by the first price advances in securities which are certain to take place when the forces of depression have at last run their course.