Dallas 2018 Economic Forecast: Acceleration

 Dallas 2018 Economic Forecast: Acceleration
By Ray Niekamp

Although Hurricane Harvey did not hit North Texas, its effects were still felt in the Dallas-area economy. But Mine Yücel, senior vice president at the Federal Reserve Bank of Dallas, thinks the economic impact of the storm will be short-lived. She forecasts the state’s economy will grow 2.5 to 3 percent this year and get back to its pre-hurricane numbers. Mine spoke at the 2018 economic forecast held in conjunction with the University of Texas at Dallas, Jindal School of Management.

(l to r) David Walls of Austin Industries, Trey Bowles of the Dallas Entrepreneur Center, Pat Hamner of Patriot Capital, Mine Yucel of the Federal Reserve Bank of Dallas, Dennis McCuistion of UT Dallas, and Dean Hasan Pirkul of the Jindal School of Management at UT Dallas.

Several factors are contributing to the healthy outlook. Jobs have been added in most sectors, Yücel said, and once again, the job growth in Texas is running ahead of the nation as a whole: 2.6 percent versus 1.5 percent. The stabilization of oil prices at about $50 per barrel allowed for oil & gas to add jobs, and the falling dollar has led to an increase in manufacturing-related exports, she said.

Of all the sectors in the economy, oil & gas, which is up almost 12 percent year to date, has shown the greatest growth. Shale oil producers continued producing after cutting costs and improving efficiencies. Production is up in September to 3.62 million barrels a day, and the rig count has more than doubled since it started moving up again in May of 2016. “Permian is going strong, and Eagle Ford is slowing down,” Yücel said. “In the Permian there’s 2.5 million barrels a day coming out, and Eagle Ford is about 1.25.”

Mine Yucel is Senior Vice President and Special Advisor at the Federal Reserve Bank of Dallas.

However, lack of labor is having an effect in most sectors, she said. The construction sector is up only 1.8 percent, with 8,300 added jobs. “We think that is due partly to a slowdown in the housing sector and probably also due to a lack of labor,” Yücel said.

New home construction is weakening, and multifamily home construction is about where it was last year. “There’s a lot of product on the market, costs are increasing and banks are less willing to lend,” she said. Most of the slowdown is in Houston area, which pulled back after the oil bust of 2015.

“I think you’ll see a large increase in multifamily in the next couple of months because of Harvey,” Yücel said. “There will be a lot of building if we can find the labor.”

Single-family housing permits have flattened in the last year, but they’re still up over 8.8 percent year over year. “The Texas housing market is tight,” she said, “especially in Dallas and Austin, where inventory is very low.”

On the service side, every sector except information added employees, Yücel said. Professional services—accountants, lawyers and engineers—added the largest number of jobs, about 42,000. That represents a 3.9 percent increase. Leisure and hospitality was up 3.4 percent, but most of those jobs were restaurant service jobs, meaning more people were going out to eat. “When the next data comes out later this month, you’ll see that sector go down due to the hurricane,” Yücel said.

Yücel wrapped up with an assessment of Hurricane Harvey’s effect on the economy. “It’s clear the hurricane is going to have negative, but transitory, effects on employment, the energy sector, exports and the retail sector,” she said. “The recovery in construction will boost growth and wage inflation in the coming months, but you have to remember Texas unemployment was 4.3 percent in August, the lowest in a decade. There’s already a tight labor market, so this is going to cause wage increases and impact the labor shortage.”

She said direct costs from Harvey—affecting personal property, commercial infrastructure and livestock—range between $86 and $108 billion, second only to Katrina. Job loss is placed at between 40,000 and 60,000, but Yücel said we are expected to return to normal by the end of the year. About 62,000 single-family homes and 11,0000 multifamily units were damaged or destroyed. “Reconstruction will lead to wage increases,” she said. And with roughly 360,000 new and used cars destroyed in the hurricane, “The auto dealers are going to have a good time selling cars,” she said.

Risks to the state’s recovery include low oil prices and labor shortages, Yücel said. But the upside is solid growth both here and across the United States. “Barring any unexpected shocks,” she concluded, “we think Texas will grow at 2.5 to 3 percent for this year, and we think next year could be even better.”

Construction

“Of all the indexes we look at, we see a good market all across the country” said David Walls, the president and CEO of Austin Industries. “If Trump puts through his tax cuts, there will be more investment from the cut in the corporate rate.”

David Walls is President & CEO of Austin Industries.

He said the Architectural Billing Index is a good indicator of strength in the construction industry. “The multifamily and commercial sectors are on fire these days, especially here in Texas,” he said. But he reiterated Yücel’s concern about the shortage of labor: “Manpower is a problem here in Texas, especially for all the subcontractors who are trying to keep up. Labor shortages are really a nationwide problem. The construction industry is not attracting people like it used to.”

Walls said the country has “one heck of a problem” with infrastructure. To fix everything would cost about $4.5 trillion over the next 10 years, and Walls said we have only enough money to fix about half of it. The 55,000 bridges that need repair represent about $1 trillion of that total.

“Everywhere you go in Texas, the roads need to be improved,” Walls said. “Good airports and good infrastructure are what drive the economy.” He noted that Proposition Seven, approved by voters in 2015, adds an amendment to the Texas Constitution requiring that gas tax money, which had gone to other areas, now be dedicated to fixing roads.

Walls said the population of Texas would grow from 27 million to 55 million people in the next 20 years, and he expects that population growth to increase demand for commercial construction. “I’m sure the private sector will turn off one of these days, but not now,” he said. For the next two years, he’s “very bullish” on the private commercial sector.

He’s not as bullish on the industrial market, however. “Who could see that crude prices would stay that low?” he asked. “It’s a great thing for American consumers and the economy because it has put a lot of money back in the marketplace.” But right now, he said, the sector is seeing “hyper-competition.”

Overall, though, things look good. “I feel good about the US economy, but I feel great about the Texas economy,” he said. “We are all blessed to be here.”

Mergers & Acquisitions

When it comes to M&A activity, “We’ve had a pretty healthy environment,” said Patrick Hamner, the southwest managing director of Patriot Capital.

Patrick Hamner is Managing Director Southwest of Patriot Capital.

A number of things have come together to make it so. Slow growth in the economy meant companies had to buy earnings because it was difficult to grow organically, he said. Strategic buyers had lots of money, and so did private equity. Low interest rates, a lot of credit from lenders and high stock prices all contributed to that environment, Hamner added.

He showed a chart that had M&A activity hitting peaks in 2000 and 2007, followed by big drop-offs. In 2015, Hamner said valuations of deals hit an all-time high, and while valuations dropped a little last year, he said we’re not off the cliff yet.

He likened the private equity business to a three-legged stool. The first leg is investing. “Buy low and sell high,” he said. “Buy at five times EBITDA, and sell for seven times EBITDA, and you make money.” Second, buy a company with a lot of leverage, and deleverage it to make money. “Third, increase EBITDA with performance enhancement, professionalization and growth in earnings,” he said.

Private equity investments took a big drop—28 percent—in the first quarter of 2017 compared to the fourth quarter of 2016, Hamner said. But then, it began to pick up in the second quarter. Donald Trump’s promises of tax cuts, more spending on infrastructure, regulatory rollbacks, and higher GDP growth have spurred a buying competition among private equity groups, and purchase multiples are rising to “ridiculous levels.”

The second leg of the stool is growing the investment. “Competition among lenders is higher,” he said. “We are all going at it with intense competition, and it’s driving down returns.” If GDP grows at 3 percent, Hamner said that could take some pressure off those who are out to “buy” earnings. “We’ll see if we can get there.”

The third leg of the stool is the exit. In exit activity, Hamner said it looked like someone had hit the pause button. Generally, he said private equity groups exit about 1,300 deals a year with about $350 billion. But in first quarter, deals dropped by 30 percent, and valuations were down 58 percent, in “a shock to the system.” Although things moderated in the first half, since the peak of exit deals was reached in Q4 of 2015, exit activity is down 47 percent quarter over quarter.

Still, he thinks we might be seeing a recovery of sorts. The comeback from the Great Recession has been long and slow. “Folks are wondering if they really want to hold on to their companies through the next recession,” he said.

With exits down, one might expect fundraising to be down, too, but Hamner says that’s not what’s happening. “The rule of thumb is that PEGs raise about $200 billion a year,” he said. “The first half of this year shows we’re on a higher trajectory than that with probably $226 billion.” Private equity groups are sitting on about $550 billion. “If you’re an entrepreneur looking for money, you’re loving this,” Hamner said.

Purchase multiples have gone from 9.5 times EBITDA in 2006, to 7.7 times last year. “If you’re a mid-cap and in the bigger deals, then you’re at 10 to 12 times,” he said. The amount of equity necessary to do a deal has risen, too. Now, it takes 50 percent equity and a super-high price, he said.

Finally, Hamner said for mezzanine financing, the average internal rate of return was in the mid-20s in 1995 and is now down to 16 percent. Average buyout IRR started in the mid-30s and is now down to 17.5 percent. “There’s a 1.5-point spread between the guys building equity who are taking all the risk and doing all the work to build those companies,” he said, “and mezzanine guys like me, who are just lending money to them for five years and allowing the equity to do most of the heavy lifting—that’s a small spread.” But he said private equity firms he talks to say they’re not even seeing 17.5 percent.

“You’d better model your deal with a lower exit multiple than entrance multiple, because in the next five years, it’s not going to keep going up,” Hamner said. “We are all standing on the cliff, and I don’t know if we should jump off or not. It’s crazy.”

Entrepreneurship

Dallas, and North Texas in general, is one of the top five or six most entrepreneurial areas in the United States and the world, according to Trey Bowles of the Dallas Entrepreneur Center. He said 19,000 new business start in Dallas every year, and when the greater DFW metroplex is considered, the number is closer to 40,000.

Trey Bowles is CEO of the Dallas Entrepreneur Center

“Why would you be in this specific region?” Bowles asked. The area has the community that’s necessary to help businesses grow. Bowles said the area has 30 VC funds, angel groups and growth funds, more than 65 co-working or shared-working spaces encouraging collaboration, 40 accelerators and incubators and 18 corporate innovation centers.

Bowles did a SWOT analysis of entrepreneurship in North Texas. “One of our strengths is the ‘can do,’ entrepreneurial spirit that’s built into the DNA of Texans,” Bowles said. “If somebody has an idea, nine out of ten times, we’re going to encourage people to go forward.”

Another strength is the number of corporations headquartered in North Texas. “With the high density of corporations headquartered here, or the ones with a large presence here, that’s a large opportunity for early-stage companies to grow and raise funding by acquisition,” he said.

In weaknesses, Bowles said the area doesn’t do enough to promote its successes. “We have to get a bit more excited about sharing the wins, because that drives momentum, which drives capital infusion, and that drives more VCs, and that drives more entrepreneurs,” he said.

He sees an opportunity for corporations to connect with early stage entrepreneurs to drive innovation. “As an entrepreneur you can make more money by having your residence in Texas because of our tax setup,” he said. “When you see a city make a concerted effort toward innovation, that goes out through all our citizens.”

And in threats, “There could be an economic breakdown of the markets,” Bowles said. He said entrepreneurs are often forced to start businesses because they don’t have jobs. “We also need more exits,” he said. “I think we have them, but people just don’t know about them.”

Bowles said after a year and half of existence, the Dallas Entrepreneur Center’s early stage entrepreneurs generated nearly $100 million in revenue, raised $115 million in funding and created nearly 1,000 jobs. He predicted that would grow to 10,000 jobs in the next 10 years.

“I think you need three types of innovation,” Bowles said. “You need corporate innovation, civic innovation and startup innovation.” He said that’s taking place now in Dallas’ historic West End, where 25 partners have joined to make the infrastructure of the area more efficient. Without those kinds of ventures, Bowles said, we will not be able to handle the influx of people to Dallas by 2050.

Q & A

Dennis McCuistion, a TV host and clinical professor at UT-Dallas, moderated a question and answer period. He asked Dennis Walls why P3s are potential solutions to our infrastructure problems. “I think the private sector does a better job with money,” Walls said. “If we’re going to continue to grow the state, I think you’re going to have to have some private entrepreneurship to operate these projects.”

Dennis McCuistion is a TV Host and clinical professor at the University of Texas at Dallas

McCuistion asked about factors that could put a damper on the state’s economic outlook. “One thing that’s important is that we are lacking labor,” Mine Yücel replied. “We need more people to work. Until now. we’ve had a pretty good relationship with Mexico on our southern border and the labor from that country has helped us grow quite a bit.” She said Texas needs more people to come here in order to keep growing.

Regarding NAFTA, Yücel said the trade agreement has been good for Texas. “It would behoove us to keep it,” she said. “There are probably ways to improve NAFTA.”

David Walls echoed that position. “We need these craftsmen and craftswomen in the construction industry, in the food service industry—there are so many areas where we are all the beneficiaries,” he said.

 

 

 

 

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