Dallas – 2017 Economic Forecast: Resiliant

By Dacia Rivers

Photography by Shannon Drawe             

 Moderator Dennis McCuistion, a clinical professor at the University of Texas Dallas and host of KERA-TV’s McCuistion Report, welcomed attendees to the 2017 Economic Forecast event in Dallas, where a panel of speakers offered insights into the current state of their respective industries and gave their predictions for what’s next on Texas’ business horizon.

Regional Forecast

Miné Yücel, senior vice president and director of research at the Federal Reserve Bank of Dallas, kicked off the city’s economic forecast with some positive news for Texas’ economy, bringing with her some positive numbers just released from the Texas Workforce Commission.

“The worst may be behind us,” Yücel said, “and while there are still risks, we are seeing some positive signs.”

Texas typically has a faster job growth rate than the rest of the country, but the energy bust has stifled that growth recently, with Texas job growth reaching 1.3 percent in 2015, compared to a 2 percent growth across the U.S. that year. After negative job growth in the first quarter of 2016, jobs in Texas grew 1.4 percent in Q2 and 2.9 percent in Q3 for a year-to-date growth of .9 percent, compared to 1.5 percent nationally. Jobs in Texas have grown at about half the U.S. rate during the energy slump, Yücel said, particularly in the goods sector, where jobs declined until Q3, while service jobs have continued to grow despite a slight slump in Q1.

Since the energy sector’s downturn, manufacturing, construction and energy jobs in Texas have been on the decline. The energy sector lost about 22,000 jobs this year, but things started looking up in August, with small growth returning.

Front Row (l to r) Mine Yucel, Bud Applebaum, Will Hodges and Lee Bird. Back Row: Dean Hasan Pirkul and Dennis McCuistion
Front Row (l to r) Mine Yucel, Bud Applebaum, Will Hodges and Lee Bird.
Back Row: Dean Hasan Pirkul and Dennis McCuistion

Texas lost about 15,000 manufacturing jobs this year, as well. However, Yücel said these job declines seem to have hit their lowest point in the second quarter of 2016 and are now moving back into positive territory.

“We’ve seen job losses in [the energy] sector since January 2015, until August, when hiring turned positive,” Yücel said. “It was a small number of jobs at 208, but it was positive.”

Dropping oil prices have brought down many aspects of the state economy, but Yücel said the price of oil had risen to about $50 a barrel, boosting the industry. Besides increased oil prices, she pointed to the weakening value of the dollar, a trend that helps Texas by making it more competitive with the rest of the world in terms of exports.

“If oil prices continue to firm up, and if the dollar doesn’t strengthen, the manufacturing sector should see the benefits,” Yücel said.

According to a Federal Reserve energy survey of oil and gas firms, executives believe when oil reaches between $55 and $65 per barrel, the market will be much more active. Most respondents also said that they expect that increase to come in the second quarter of 2017, and they’ve already seen increased business activity continuing to ramp up in Q3.

On the service side, jobs are increasing in the areas of education, health and financial activities. Most of Texas’ job growth has come in the areas of leisure and hospitality, especially restaurants, with 12,000 new jobs added in the leisure and hospitality sector in September.

Of all of Texas’ metro areas, Yücel said Dallas is experiencing the greatest job growth, adding about 10,000 jobs in August and 40,000 in the first three quarters of 2016, for an overall growth rate of 21 percent. To Yücel, these numbers show that job loss has hit its bottom and is now bouncing back, even in Houston, where jobs are starting to recover from lower oil prices.

The existing home market in Dallas is still tight, with a two-month inventory reported in August and median prices increasing 9.3 percent year over year.

Construction is still a volatile industry in Texas, but Yücel said that non-residential construction has started to pick up, mostly in the Dallas-Fort Worth area. Also in the Metroplex, multi-family real estate is a hot market, and apartment rentals and construction are on the rise. Dallas is home to 10 percent of all new apartments being built in the U.S. right now.

Yücel said unpaid loans in Texas are on the decline, and oil production is starting to climb again, two signs that the economy is starting to recover. She said that while she doesn’t expect to see 3 percent growth in 2017, she does expect to see positive growth in general for the Texas economy.

“I think the word ‘resilient’ is quite apt for this event in Texas,” Yücel said. “We have been resilient and we have not gone into a recession.”

Retail

Headquartered in Plano and formerly known as Garden Ridge, At Home is a retail business specializing in items for the home. The company went public in August and is growing more than 20 percent per year. At Home’s president and CEO, Lee Bird, spoke to attendees about what he expects for the future of retail, focusing on four industry trends.

The first trend began in 2008, when the retail industry saw a fundamental change in where consumers shop and where they spend their money. Bird noted the shoppers who were only spending money in luxury brands became very careful with their money and went to shop with the value brands. Since then, value brands such as Old Navy have experienced growth, while luxury brands such as Burberry, Dior and Chanel have had to re-envision their sales strategies; and the bridge brands such as Banana Republic, J Crew and Coach are now being squeezed.

Bird said luxury brands have moved into the outlet and off-price channels to try and cover the shortfall at full-price stores. He said that value retailers, such as Ross and TJ Maxx, have had the highest growth in opening new stores since 2008. “The guys who are growing are the ones who buy somebody else’s brands and sell them at a value price like Ross, Burlington and TJ Maxx,” observed Bird.

More money-conscious consumers are willing to shop at discount stores, even if they don’t admit to doing so, and The Dollar Store is opening thousands of locations across the U.S.

Teens, in turn, have been spending more money at value brands such as Forever 21 and H&M, where they can get the same looks, just without a name-brand label, at cheaper prices.

One new trend Bird sees in retail is the growth of the omnichannel. While brick and mortar stores in past years moved quickly to create online e-commerce channels, now online-only stores are opening up physical locations to give their customers a full brand experience. Birchbox, Bonobos, Amazon and Warby Parker are all online-only “e-tailers” that have recently opened brick-and-mortar locations.

“The customer just can’t get the full experience with a brand until you put it in a store,” Bird said. “These e-tailers are going to brick and mortar because everyone is looking for a full relationship with their customer.”

The third trend Bird pointed to is the changing face of the American mall, and it’s a trend he expects will continue into 2017 as department stores shutter their mall locations. With Macy’s and Kmart recently announcing the closing of 100 stores each, developers are looking to change the structure of indoor malls. More malls are being torn down or imploded and reimagined as power centers — shopping destinations with outdoor areas, fountains, and restaurants, with shops anchoring the areas.

Bird said he believes these power centers and destination shopping locations are interesting, and added that malls may still provide a viable shopping experience if they are redeveloped to keep up with consumers’ wants.

“The ones that are thriving are always looking at the customer, and the rest will die off,” Bird said.

Conscious capitalism is an emerging trend in the business space, and one that Bird feels is a great move for retail. Millennials flock to the companies that focus on providing benefits and incentives to employees. A TimeTrade Research study found Millennials are 31 percent more likely to buy from a purpose-driven retailer.

“In my view, that is the way to run a company today,” Bird said. “Purpose-driven companies are those with a soul who take really good care of their employees.”

At Home raised its hourly pay for full-time employees to $10 per hour, and also added 401K plans with matching funds, time off for charity work and a bonus program. Walmart also moved to paying $10 per hour shortly after At Home, and experienced sales growth the company directly credits to the wage increase.

These “Firms of Endearment” are experiencing long-term financial success as a result of their conscious capitalism, delivering an annualized return that is three times the S&P return on a ten-year, five-year and three-year basis.

“Consumers are looking for mission-driven companies, and employees are going to those companies,” Bird said. “It’s a war for talent out there, and you want to have the best people.”

Private Equity

Jay “Bud” Applebaum of Wingate Partners addressed the state of private equity investments in Texas, saying that while M&A transactions are down in volume by about 7 percent, the dollar amount associated with transactions is up about 29 percent. He cited low interest rates as being the driving factor behind this inequity.

“Investors of all different kinds, whether they be individual households, institutions, pension plans or endowments, they’re all seeking higher yields on their money,” Applebaum said.

In the search for higher returns, a lot of investors are putting their dollars into debt capital, where the funds provide capital for businesses. The return is higher, but so is the risk.

“The reason we keep seeing all this increased supply in capital is because the traditional forms of investment, whether they be money market funds or government bonds, just don’t yield very much income,” Applebaum said.

Because investment transactions are decreasing in number, but the amount of capital invested has risen, Applebaum expects a squeeze on the cost of capital, which he believes could translate into higher purchase prices and valuations. He said he believes there is currently too much risk for the reward.

With private equity firms, Applebaum said the industry is actually doing well right now, and that 2014 and 2015 were record years in terms of the amount of capital distributed by private equity funds to their investors. The downside of this, Applebaum said, is that more capital is attracted to private equity now because of this performance, which will drive up the valuations and purchase prices.

Today, there’s nearly $1.5 trillion in “dry powder,” which is the capital that is committed and available to private equity firms but isn’t yet invested. “You can see where this is going,” declared Applebaum. “There’s a lot of capital, prices are high, and there’s still a great deal of competition.” This has led many in the field to question what these investors and PE funds are thinking, and what they see in the future.

“We are still in an environment and economy of uncertainty,” Applebaum said. “It’s my opinion that many investors are simply not being rewarded for the risk they are taking, and history says when that happens, there are bad things around the corner.” How will this play out?

Applebaum says he is unsure what the future of investing will look like in Texas, but he believes interest rates will start to increase at some point, which will help investors hungry for returns. When that happens, there will be fewer dollars flowing into private equity for investing, and less debt capital will mean less pressure on purchase prices. As purchase prices come down, a number of the investments from today will likely have exits at valuations lower than the entry valuations. If or when that happens, Applebaum says that would be bad news for both debt and equity investors

“Debt will come down, but so will the number of managers because there will be a thinning out of PE funds and debt funds,” stated Applebaum. Timing is difficult to predict and he suggests caution while working through today’s increasing valuation and purchase price environment.

The future could include decreased purchase prices, and although Applebaum described today as a seller’s market, he does see things getting better for buyers.

“There’s going to be some dislocation and there’s going to be some pain, and then the environment will get better,” Applebaum said.

Construction

Construction sites are ubiquitous across Texas, and Dallas is no exception. Will Hodges, president of Cadence McShane Construction (CMC), described the amount of construction going on in the Dallas area as “astronomical.” In addition to their Dallas headquarters, CMC operates in Houston, Austin and San Antonio, and in several business sectors.

“If you drive around Dallas and up to Frisco, you’re going to see billions of dollars worth of construction,” Hodges said. “You’re going to pass 25 or 30 tower cranes along the way.”

In the education sector alone, there have been between $15 and $17 billion in K-12 school bonds passed since May 2014, and Hodges expects at least another $10 billion to be approved over the next 18 months. Additionally, he has seen petrochemical construction continue to increase on the Gulf Coast, with an estimated $40 billion dollars expected to be spent between Corpus Christi and Beaumont over the next seven years.

“The overall numbers in the industry look really good,” Hodges said. “Construction revenues for most companies are approaching where they were in 2007, 2008 and 2009, right when we started to see our downturn.”

Hodges refers to this glut of construction as a “wall of work,” something he feels is easy enough to tackle. It’s the accompanying “wall of worry,” that’s keeping him up at night. First of his worries is the amount of risk construction companies are taking on from developers for little return. Hodges said most best-in-class contractors pull in just 2 percent profit in pre-tax earnings. Construction costs are rising and the industry has issues attracting and retaining talent, and keeping up with evolving equipment and technology.

The second “wall of worry” issue is the lack of talent in the industry. With inexperienced workers come expensive mistakes — in some cases the difference between profit and loss on a project. It’s a long-term issue that Hodges suggested needs to be addressed by educating children as young as junior high about the value of being a contractor and working in the construction business.

Declining oil prices have led to cutbacks in many oil construction jobs, but Hodges said those workers aren’t signing up for general construction, but pivoting instead to other petrochemical jobs such as welding and pipeline maintenance, so they can stay in the same areas they’ve worked in previously.

One of Hodges’ greatest concerns for the construction industry is the risk transfer he’s seen occurring since 2008. Banks and equity firms have been shifting the risk for construction projects to the contractors in a way Hodges says is unprecedented.

“The contract language we are seeing today is so onerous and so difficult for a contractor to sign,” Hodges said. “I call it ‘bet the company’ language, because there is language in there that if I sign, I’m betting the company on that one job.”

He pointed to an example for a $100 million high school project, where his company negotiated contract language for three weeks and still had to walk away from the project because it placed too much risk on his business. He said multiple contractors will walk away from that job for the same reason, ultimately leaving the taxpayers who paid for that project in a difficult position. Fortunately, general contractors have begun to push back.

Despite the worrisome combination of low margins, inexperienced staff and risky contract language, Hodges said he doesn’t see construction in Texas slowing down over the next two to three years, at least. He mentioned while he has concerns, other construction companies are taking on as much work as they can, looking at top line growth only. Hodges believes many of these general and subcontractors will wind up out of business just because they won’t be able to manage the rapid growth.

Looking forward, Hodges expressed concern that government agencies such as the Department of Labor and OSHA are adding increasing rules and regulations on the industry that make it more difficult to do business, such as overtime requirements and a ban on post-accident drug screening. He also mentioned his fears of what could happen in Texas if labor unions come into the state, explaining that the cost of construction is often 40 to 50 percent higher in states with unions. Hodges says labor unions are targeting the south for growth, in large part to deal with their pension fund liability.

Despite these worries, Hodges said he feels confident in the construction industry in Texas. He pointed to the continuing job creation in the industry and the frequent corporate relocations into the state as good indicators for the future of construction.

“We are in the best state in the country to do business,” Hodges said. “We have a good business environment and it’s a free enterprise, so I’m really optimistic about where we are.”

Dacia Rivers is a writer & editor for Texas CEO Magazine.

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