Manufacturing: Which Companies Will Recover First?

For those encouraged by the stream of improving economic data in recent weeks, jitters are more and more giving way to confidence that the worst of the recession has been seen—and that it won't be long before signs of recovery start to appear. One example: While the Institute for Supply Management's April data showed contraction in manufacturing production for the 15th consecutive month, it was at a slower pace than in March. And a six-percentage point spike in the New Orders Index, one component within the ISM Purchasing Managers Index, puts it on the verge of showing an increase in manufacturing orders.

Restoring the manufacturing industry to health won't come easily after the 15% plunge that production took in the 12 months ended Mar. 31, the biggest one-year drop since the end of World War II, according to Charles McMillion, chief economist at MBG Information Services in Washington, D.C. The scattered evidence of stabilization across the sector shouldn't be mistaken for signs of widespread recovery anytime soon, especially given most companies' lack of any kind of pricing power, he says.

Although McMillion believes the rate of decline in production would be slowing even without the stimulus package, he worries about the impact a possibly extended shutdown of production at General Motors (GM) and Chrysler could have on auto-parts producers. "There's a lot of uncertainty coming at us as automakers try to get their inventories under control," he says.

Betting on the Government

In terms of scale, highway construction and other forms of heavy construction will probably account for the biggest portion of the rebound in manufacturing. With $27.5 billion earmarked for highway and bridge construction projects, it is the biggest single-line infrastructure item in the final version of the Obama stimulus package. A total of $80 billion has been allocated to infrastructure projects.

"Right now, the government is the horse that everybody is betting on because of the stimulus plan to start spending on roads and bridges and other activity that will help push some manufacturing production growth," says McMillion. "And the jobs that are created from that will hopefully create at least a little bit of additional consumer spending and then we can expect some business spending [on manufactured goods]."

Given how low capacity utilization rates of property, equipment, and labor are, McMillion says he doesn't expect to see much new investment in manufacturing capacity.

Hopeful Signs for Steelmakers

U.S. steelmakers such as Nucor (NUE), Steel Dynamics (STLD), and Commercial Metals (CMC) are all poised to benefit from a boom in heavy construction, since they make the long steel products used to reinforce cement and in other aspects of highway construction. Producers of flat steel products such as United States Steel (X) and AK Steel Holding (AKS) won't be as fortunate, since they are mainly suppliers to the auto industry.

The entire U.S. steel industry is now running at around 40% capacity utilization, which Rick Del Los Reyes, a metals analyst at T. Rowe Price (TROW) in Baltimore sees as unsustainably low. The reason? Manufacturers will have to replenish steel inventories after using up existing supplies. "The expectation would be that as inventories dry up, you'll see restocking happen. That can get utilization rates back into 50s and 60s [percent ranges] as opposed to the 40s, and will be very positive for margins," he says.

The recent rise in scrap steel prices is another encouraging sign for steel demand. The price of North American shredded scrap jumped 18% from April to May, but that was off a very low base, with scrap prices having fallen from $900 to $150 a ton by the end of 2008, he says.

A Weak Dollar Offers Support

The addition of new capacity with a new steel mill being built in Alabama by ThyssenKrupp will continue to weigh on the industry, however, and raises the question of whether some producers may have to permanently shut down some plants if demand doesn't pick up soon, says Del Los Reyes.

Until then, a weak dollar would offer some support to steelmakers, too, since it would help keep foreign steel imports out of the U.S., he adds.

The quickest bounce is likely to be in the production of liquid crystal display (LCD) glass for televisions and computers. Best Buy (BBY) is running out of inventory of LCD TVs and in spite of the weak economy, supply won't be able to keep up with the pop in seasonal demand with Father's Day and college graduations around the corner, according to Jim Suva, an analyst at Citigroup (C) in San Francisco.

Focus on Energy Efficiency

The only North American manufacturer of LCD glass is Corning (GLW), whose only two competitors are based in Japan. The main reason for the shortage is Corning's cutting its production by 50% after disappointing holiday sales. It will take Corning about a month to get its LCD production back up to speed, Suva says.

The recovery prospects also look good for electronics manufacturers that focus on energy efficiency. Companies with divisions that make light-emitting diode (LED) lighting fixtures such as Acuity Brands (AYI) and Cooper Industries (CBE) are expected to benefit from the retrofitting of schools and other government facilities with energy-saving products, to be covered by the stimulus package, says David Gordon, a principal at Channel Marketing Group, a marketing consulting firm in Raleigh, N.C. Companies that make LED chips and other components, such as Cree (CREE), will also be able to ride a shift to these energy- and cost-saving devices, he adds.

Longer term, there will be opportunities from the planned phase-out of incandescent lightbulbs under the 2007 energy bill, which is set to begin in 2012 with the ban on 100-watt bulbs. If consumers plan ahead or are motivated enough by the promise of being able to lower their monthly electric bills by replacing incandescent bulbs, the market for compact and linear fluorescent bulbs (CFLs), and to a lesser extent LEDs, could heat up fairly soon, says Gordon. Most CFLs are made in China, but there are a few privately held U.S. producers that stand to profit from them as well.

A Revolution in Lighting

One of the major drawbacks of CFLs—their crude dimming capabilities— will soon be resolved, too. This week, a new fully dimmable CFL made by PureSpectrum is being rolled out at lighting fairs and should help jump-start that market, says Gordon.

The clearest beneficiaries of the 4.5 billion light sockets for incandescent bulbs that need to be serviced with CFLs come 2012 will be Home Depot (HD) and Wal-Mart Stores (WMT), which currently control most of that market, Gordon says. As orders begin to flow once more to bulb makers and other firms, the beleaguered U.S. manufacturing sector may just be seeing the tiniest flickers of the light at the end of the tunnel.

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