Order Backlog - Limitations and Implications

Understanding the Role and Implications of Order Backlog in Company Analysis and Evaluating Future Performance
2024-04-03 · epsilontal · Symbols: UNIT.TA,TLSY.TA
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"Order Backlog" is a term commonly used in reports over the last three years. It has become relevant in various sectors due to different crises, such as the maritime shipping crisis leading to maritime congestion, the chip crisis, post-war situations, and the defence sector.

This item made company analysis more effortless, and many investors relied more heavily on the order backlog in their analyses.

In times of high-interest rates, customers prioritize inventory management to avoid expensive credit by paying advances.

The chip and maritime shipping crises no longer affect us, and we need a deeper analysis of companies' products, potential, and strategy implementation.

Examples of how the chip crisis has affected companies can be found among those I have written about before. One such company is Unitronics ($UNIT.TA), which typically delivers products to its customers within a few weeks under normal circumstances. However, during the peak of the chip crisis in 2022-2023, the company experienced a significant backlog of orders.

Another example is Telsys ($TLSY.TA). In years with brief delivery times, it may exhibit a low order backlog at the beginning of the year, while at year-end, it may report actual sales that are many times greater than the backlog.

Relying solely on order backlog in analysis poses several risks. These risks include:

  1. It is a common mistake to assume that if a company has a low backlog, its performance in the upcoming year will be poor, resulting in missed opportunities.
  2. Typically, suppliers require low advance payments to secure the order and meet the delivery date. However, certain conditions may cause the transaction to be cancelled.
  3. A high backlog does not always mean that the company is meeting the demand, as production/supply capacity limitations can cause the backlog to be delayed and carried forward from one quarter to another.
  4. A sudden increase in order backlog may lead companies to expand production capacity, incurring additional operating costs when the demand returns to normal levels.
  5. A high order backlog can pose difficulties in inventory management, as companies may be forced to complete inventories, leading to increased demand for raw materials and reduced profit margins.

It's important to note that a company having a significant increase in their order backlog doesn't always mean they're exceeding their production capacity. It could also indicate natural and healthy growth. To determine whether the increase in the backlog is a one-time occurrence or organic, it's crucial to have a thorough understanding of the company's operations.

A backlog of orders can give us an idea of a company's activity for the upcoming year. But, it's essential to remember that it could also be misleading and give us a wrong impression. That's why it's crucial to look into the company's products and ability to grow organically over time while ensuring timely delivery to its customers. Doing so can give us a more accurate picture of the company's quality.