Canada Factories Count on U.S. Pickup to End Recession

Canadian manufacturers, dogged by the effects of a strong currency, are counting on a pickup in U.S. demand to end the sector’s deepest contraction since 2009.

Canadian factory production has shrunk 2.7 percent since the end of 2011 and is 7.6 percent weaker than it was in July 2008, right before the country slipped into its last recession. Aside from agriculture, manufacturing is the only part of the economy that has failed to return to pre-slump levels.

Montreal-based Saputo Inc., the nation’s largest dairy processor, and Peoria, Illinois-based construction and machinery maker Caterpillar Inc. are among companies shutting plants in Canada amid rising wage costs and tepid demand from the U.S., which buys about 75 percent of Canadian exports. Weakness in manufacturing, which accounts for 11 percent of gross domestic product, is holding back the world’s 11th largest economy.

“The Canadian manufacturing sector continues to struggle against the collective headwinds of a sluggish U.S. economy and the persistent strength of the currency,” said David Tulk, chief macro strategist at Toronto-Dominion Bank’s TD Securities unit. If the U.S. private sector can sustain growth, “there is a certain amount of pent-up demand for manufactured goods out of the American economy.”

Between December and June, Canada lost 11 factory businesses with more than 200 employees, according to Statistics Canada data, representing 3.4 percent of all companies. More closures are coming. Stockholm-based Electrolux AB, the maker of Frigidaire ovens, is planning to shift output to Memphis, Tennessee, from a plant near Montreal next year.

Canadian Dollar

Manufacturers are contending with a Canadian dollar that has risen 52 percent against its U.S. counterpart since the end of 2001. This has boosted the price of exports, making them less competitive, and increased production costs, such as wages, relative to the U.S. When measured in U.S. dollars, unit labor costs in Canada have increased 92 percent since March 2003, compared with a 12 percent rise for American businesses.

Since June 2009, when the U.S. economy emerged from recession, the average Canadian factory wage has increased twice as fast as in the U.S., according to Statistics Canada and U.S. Labor Department data.

Stronger U.S. growth has the capacity to offset those challenges, said Mark Chandler, head of fixed-income strategy at RBC Capital Markets in Toronto.

“The big thing that’s happening is that domestic demand is poised to improve with a fair degree of confidence in the U.S.,” Chandler said. “Canadian manufacturers are well positioned to benefit.”

Stock Prices

Canada’s benchmark stock index is underperforming U.S. equities for a third year on expectations for better U.S. growth. Canadian stocks fell 2.5 percent in the first half of the year, compared with a 13 percent gain for the Standard & Poor’s 500 Index, the largest half-year performance gap between the two indexes since 1998.

The Standard & Poor’s/TSX Index rose 0.13 percent to 12,607.22 in Toronto today, while the U.S. S&P 500 gained 0.27 percent to 1634.96.

The American economy, the world’s largest, is projected to grow 2.5 percent on average in the second half of this year, according to the median projection in a Bloomberg survey of economists from Aug. 2 to Aug. 6. The pace may pick up to 2.8 percent by the second quarter of 2014, the survey showed.

The U.S. has typically needed to post year-over-year growth of about 2.5 percent or better to generate gains in Canadian factory output, Doug Porter, chief economist at Bank of Montreal in Toronto, said in an Aug. 23 report.

‘Postwar Reconstruction’

Bank of Canada Governor Stephen Poloz said in a June speech that resurgent demand from the U.S. is critical to reviving confidence in the economy and bolstering investment in manufacturing, a process he likes to “postwar reconstruction.”

Even after U.S. growth picks up, falling capacity means it could take some time for manufacturers to re-gear plants in order to capitalize on the demand. The stock of factory space in absolute terms fell in 2011 to its lowest since the 1990s, according to Statistics Canada data, and accounted for a record-low 7.9 percent of Canada’s capital stock last year.

“Essentially, there’s some lost output that we have that we’ll never get back because of the length of time that we’ve struggled here,” Chandler said. “The lags are significantly longer because a mothballed factory can’t start up again, you need to build a new one.”

Closed Factories

The lost output is evident in the divergence between U.S. and Canadian manufacturing since 2011. Canadian output has fallen even as the Federal Reserve’s index of U.S. factory production increased 3.4 percent. The two are typically closely correlated.

“We’re not getting the so-called manufacturing bang for the U.S. buck that we would in past recoveries,” Porter said.

Motor vehicle assembly, the country’s second-largest factory industry after wood processing, has led declines over the past year, even as sales in North America rise to new post-crisis highs.

General Motors Co. has reduced output in Canada this year by 11.5 percent, as it winds down production of one of its two plants in Oshawa, Ontario, according to a report by TD Economics. Ford Motor Co. says its Canadian workers are the most expensive worldwide.

Relocating Plants

“Most of any new capacity will go to Mexico and to a lesser extent the U.S.,” said Kevin Tynan, an analyst at Bloomberg Industries.

The government is taking steps to support manufacturers. In his most recent budget, Finance Minister Jim Flaherty extended tax breaks for factories and provided new direct funding.

What factories need most is a stronger American expansion.

The U.S. economy, which buys about three-quarters of Canada’s exports, hasn’t rebounded from recession as quickly as in the past. Quarterly growth rates have averaged 2.2 percent in the four years since the slump’s end in 2009, a full percentage point less than the average over the same period after the two prior recessions.

Where demand is robust -- in U.S. housing, for example -- Canadians are benefiting.

In places like Chetwynd, British Columbia, a town of fewer than 3,000 people in the foothills of the Rocky Mountains, lumber companies such as West Fraser Timber Co. Ltd. are racing to rebuild neglected plants and replace antiquated equipment. Wood processors have boosted output 5 percent in the 12 months through May.

Capital Spending

“We are currently in, I’d say easily, our largest capital expenditure program in the history of this company,” said Larry Hughes, chief financial officer at Vancouver-based West Fraser. “Anybody who’s got money, or making money now, if they’re smart is putting it back into the mill to bring in the latest technology.”

Another reason for optimism is that investment has begun to return. Capital spending by manufacturers has outpaced the rest of the economy for three straight years and is projected to total C$20.9 billion this year, the highest since 1999.

Manufacturing output in April and May was 0.3 percent above average production in the first quarter. That puts it on pace for its first quarterly gain in a year for the three months ended June.

Statistics Canada will report second-quarter GDP data on Aug. 30, which will show whether Canada’s factories are still in recession.

In the meanwhile, Graphic Packaging Holding Co., a maker of folding cartons for food and beverage products based in Marietta, Georgia, is in severance talks with workers at its Brampton, Ontario, plant as it prepares to shut down the facility next month.

The move will eliminate about 150 jobs, according to Dave Moffat, an official with the Communications, Energy and Paperworkers Union of Canada who oversees the Ontario region.

“We’re still trying to get to the bottom of what happened,” Moffat said in a telephone interview.

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