Low Cost US – The Shift Is Underway, SLOWLY Reversing a 40 Year Trend
Over the last 40 years, US manufacturing industries have – slowly at first, but then more rapidly – spread their wings into other parts of the world. They did not do this to “be international” nor did they do it out of any sense of duty – they did it to make money. They were chasing a few different things:
- An opportunity to exploit a destructive proprietary technology to gain market share.
- Access to new customers and often in countries where the standard of living was expanding very quickly
- Access to advantaged costs – either lower cost of labor or lower cost raw materials.
They were exploiting an opportunity and they were doing it to make money. One of the consequences of the discovery of lower costs in other regions was the destruction of manufacturing in the US. While this was not the intention, it was a consequence of the free market opportunity to increase profits.
But the availability of cheap raw materials or labor did not transform the fortunes of most of the companies that took advantage – it helped them for sure – but in most cases it was an incremental improvement to a larger overall business. The relative benefits of the new location were diluted by the rest of the portfolio – the legacy piece.
Today, there is a groundswell of interest in the opportunity created by cheap natural gas in the US, and tremendous interest in ways to make money out of it. Looking at it from a parochial US view point, it’s great: it should create jobs and it should spur economic growth. However, step back and it is just the next stage of global business evolution – redeploying capital to exploit whatever offers advantage today. First it was all about America; then it was Japan’s and Germany’s turn, then Taiwan, then South Korea and China, all based on labor costs. Then the Middle East based on cheap energy, then India and South East Asia. Now it has come full circle back to the US based on cheap energy.
And it should be good, unless government policy discourages the almost inevitable wave of investment. But how to invest: here it is not so simple, as you have the same dilution effect that you have always had as industries and companies have exploited regional opportunities. The companies that will invest to exploit what is available in the US, for the most part, have capacity in the rest of the world, and lots of it. In 1995, our Industrials and Basic Materials group had an average of 66% of its sales from the US – in 2011, it was 44%. In the chart we show annual revenues from the US. We use this as a proxy also for assets, as we have seen a declining trade balance suggesting that capital has been invested outside the US to meet the sales growth.
The next several years will be a process of investment in the US and more limited investment elsewhere, with the possible closures of facilities elsewhere, particularly where there are weak economies, perhaps in part caused by the raw material and energy advantage in the US.
This week we see CAT cutting jobs in Belgium – just one move in a long line of announcements from US companies shrinking their footprint in a higher cost and lower return geography. These moves will continue, but for most companies, while the overall effect will be beneficial, based on their footprint today, the changes should be good, but more gradual. It looks like most of the easy ways to play cheap natural gas in the US have been picked over at this point (see our recent research on basic chemical margins). To benefit further (and there will be more benefit), investors are going to have to take a 5 year rather than 5 month view.