Labor costs hit middle-market companies: Golub Capital

The July 8 U.S. employment report turned in a bullish 287,000 new jobs in June, while wages on the nationwide level edged up a mere 0.1 percent.

But wages tell a different story in the middle market, where costs have been eating into bottom lines despite robust top-line gains, the Golub Middle Market Report says.

The report, compiled by lender Golub Capital, reflects year-over-year results among 150 privately held companies.

Among private middle-market companies that draw backing from U.S. sponsors, revenue rose 7.4 percent in the second quarter through June 1. That’s down from 9.1 percent growth in the first quarter.

Labor-cost inflation

But growth in EBITDA came in at only 2 percent, partly because wages and other costs bit into profits. In the first quarter EBITDA jumped 5 percent.

“We’re not seeing inflation overall, but we’re seeing inflationary pressure … in terms of labor costs,” Lawrence Golub, chief executive of Golub Capital, said by phone. “There’s been some profit compression going on for the past 18 months.”

Of the five macro sectors in the survey, information technology turned in the strongest results with a 16.2 percent increase in EBITDA, followed by 12.1 percent growth in industrials and 0.8 percent growth in healthcare. EBITDA among consumer-staples companies fell 2.8 percent and consumer-discretionary companies edged down 0.2 percent.

Revenue in all five sectors rose, led by a 15 percent jump for IT. Revenue growth in the healthcare sector lagged the group, up 6.5 percent.

“When you talk to CEOs of companies and you ask them about labor costs, almost everyone is saying that small increase doesn’t apply to them,” Golub said.

“The people hired by middle-market companies are getting paid more. The national statistics don’t reflect that.”

Golub said the healthcare sector has seen more patients enter the system because of Obamacare, but the cost of handling greater numbers has climbed. Insurers are also applying pressure on healthcare reimbursements.

“What we’ve seen in the healthcare sector is cost inflation without pricing power and, in some cases, dis-economies of scale,” Golub said. “Companies are expanding but costs are going up faster than revenue.”

In the consumer sector, profit margins held up well and even expanded as oil prices dropped. Consumer spending went up and that translated into better results. But labor costs have been tough to manage, Golub said.

In the industrial sector, the quarter’s big news is that profit margins widened, the first growth in years.

The dollar weakened during most of the quarter, making imports more expensive. That dynamic benefited the U.S. industrial sector, which broke out with strong growth, he said. In the wake of the Brexit vote, however, the dollar strengthened, causing a potential headwind for the third quarter, he said.

Among the bright spots, IT spending by businesses, related to cloud computing, has been much stronger than people expected, Golub said.

U.S. economy ‘chugging along’

Golub said the overall takeaway from the report is that it points to GDP growth of 2 percent to 3 percent a year, with earnings strength down in consumer but up in the industrial sector and IT.

The U.S. economy is “chugging along,” he said. “Overall these results are just fine. The impact on margins makes me worry, if wage pressure gets worse.”

Golub Capital teamed up with Edward Altman, a credit expert, to produce the Golub Capital Altman Index, an index based on actual sales and earnings data from middle-market companies.

Altman is director of research in credit and debt markets at New York University’s Salomon Center for the Study of Financial Institutions. The middle-market report debuted one year ago.

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Photo of Lawrence Golub courtesy of Golub Capital