Canada's Manufacturing Sector Looking Up

08/09/2012 10:15 am EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Unlike its southern neighbors in the US, Canada's manufacturers have stayed relatively stable through much of the bad times, and now they're increasingly optimistic moving forward, writes Tom Slee of The Canada Report.

You have to hand it to Canadian manufacturers: They are an upbeat bunch. Last December, a Grant Thornton survey found that despite all the doom and gloom in the world, most manufacturing firms were optimistic going into 2012.

Companies thought that increased domestic business would spur Canadian revenues and more than offset softening US sales. CEOs were confident that a strong loonie was manageable, and that there would be relatively little fallout from Europe. So far, they have been absolutely right.

Of course, these are not boom times across the board. But this year, Canadian manufacturing has remained remarkably stable with pockets of strong growth, especially in the mining, oil and gas, and power industries. The auto sector is resurgent.

According to PricewaterhouseCoopers, 76% of Canadian manufacturers surveyed at the end of the first quarter were optimistic about their domestic operations, compared to 57% towards the end of 2011. More than 40% of the firms were planning major capital investments. Perhaps most encouraging, many of the executives complained about a shortage of skilled labor. That is one problem that we should be able to solve.

It’s also good to see that Western Canada’s major energy projects are finally having a ripple effect. According to Jim Prentice, vice chairman of CIBC, studies show that for every dollar currently spent in Alberta on the oil sands, there is an economic benefit to Ontario of 31 cents.

Longer term, there are now close to $290 billion worth of Canadian capital investments in the pipeline as a result of growing demand for our resources. At long last, we are going to process and add value to products, rather than just ship raw materials.

I mention all of this because Canadian manufacturing companies receive relatively little media or analyst coverage. Accounting for about 2% of the S&P/TSX Composite Index, these few stocks are always overshadowed by energy, precious metals, and financials.

With just a handful of thinly traded Canadian manufacturers to choose from, most institutional money managers look to the US markets for their secondary stocks. Yet some of Canada's domestic companies are performing well despite a spluttering recovery.

As a result, there are some excellent opportunities for investors who want to balance and diversify their portfolios.

One thing that we have to bear in mind, though, is that Canadian manufacturers are increasingly dependent on the American market—so much so they expect to generate about 45% of their revenues from the US during the next year or so. Therefore, we continue to keep an eye on the American scene. Right now, it’s a mixed bag from a Canadian perspective.

The crucial US residential housing market remains a dead weight...but even here there is some good news. Inventories of single-family dwellings are now almost in line with historic norms. Elsewhere, commercial aerospace orders are strong, and Boeing (BA) has an eight-year production backlog.

On the downside, defense cuts of 5% per annum are expected to hurt many suppliers. One oddity is that the mild winter reduced the number of auto accidents, and there was less demand for repair parts. That may seem to be an insignificant item, but the annual US collision market is worth a staggering $42 billion.

Looking ahead, leading indicators such as the Institute of Supply Management (ISM) Purchasing Managers Index suggest industrial production growth at slightly below 2011 levels. In May, the ISM stood at 53.5%. A reading in excess of 42% indicates an overall expansion.

It’s interesting to note that furniture, appliances, and electrical equipment are particularly strong right now. Standard & Poor’s believes that we will also see 13% earnings growth this year in its industrial machinery sub-index.

Pulling it all together, it seems that manufacturing on both sides of the border is stronger than the depressing economic forecasts and some headlines would suggest. Analysts are cutting their 2012 US GDP estimates from 2.3% to 2%, and Canadian GDP grew at 1.9% in the first quarter—well below the expected 2.2%—as government cutbacks started to bite. At the same time, though, many manufacturers are continuing to do well.

The disconnect, I suspect, is that a lot of the increasing industrial profits result from improved efficiencies. Canadian and US plants are still being closed, and companies need fewer employees. There were 264 American manufacturing mass layoffs (more than 50 workers) in May alone. It’s a very unfortunate situation.

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