Are the Stars Aligned?: Medical Manufacturing

Manufacturing was a star in 2011 and looks to shine brightly in 2012.

Many questions remain about what 2012 will be like for U.S. manufacturing, for business in general and for profits and losses. A crystal ball is all we need. Unfortunately, they are notoriously unreliable. So we have to rely on humans and their best statistical guesses.

Judging from recent statements from economists about third quarter results from the country’s leading manufacturers, the Great Recession isn’t just over, it’s history. Large manufacturers like Eaton Corp. and Ford Motor Co., as well as hundreds of others, reported record third quarter earnings. This could mean 2012 is going to be another banner year for U.S. manufacturers.

This year saw a major disaster in Japan as a tsunami destroyed thousands of lives and billions in property. The disruption in the supply chain from Japan to the rest of the world was major and continues. Further bad news came as the United States’ credit rating was downgraded by a major rating agency. Another agency is expected to do the same. The credit crisis in Greece and perhaps other European countries is a constant worry for U.S. bankers and industry. The federal government is continuing to wrestle with enormous deficits and debts.

These situations seem to offer nothing but pessimism about the near-term future. Yet industrial companies, in particular, continue to do well. Many research firms, private companies and trade groups note the robustness of the manufacturing sector and suggest it may continue well into 2012.

“The economy accelerated 2.5 percent in Q3,” reported Bank of America Merrill Lynch in early November. “An improvement in domestic demand and inventory rebuilding has led us to revise Q4 GDP growth to 3.0 percent from 2.3 percent. In our view, the recent improvement is not a fluke and the chance of a near-term recession is low.” But, while growth may be firming, it sees “a softening to just 1 percent annualized at the end of 2012” for the entire economy.

Others predict a growth rate above 2 percent next year for the economy as a whole. It will depend on many of the same factors that shaped 2010 and this year and how one interprets the numbers.

Aerospace Still Flying

Looking at the aerospace industry, data from the U.S. Census Bureau indicates that new orders for the second quarter of 2011 were down slightly compared to the first quarter. However, looking at the first half of 2011, total orders and aircraft and parts orders were up from 2010, 6.6 percent and 10.1 percent, respectively (see Figure 1 in the online version of this article on www.ctemag.com). Even more optimistic numbers can be found, the Aerospace Industries Association reported, in the aircraft backlog, which stood at $451 billion, up 4.3 percent from 2010 (see Figure 2, online version).

Quarterly reports from large aerospace manufacturers provide a more recent and positive indicator of market conditions, according to the AIA. “For example, Boeing represents virtually the entire U.S. market for large commercial aircraft,” said Bill Chadwick, AIA director of research. “At the end of the third quarter of 2011, Boeing’s net orders were up nearly 15 percent compared to the same year-to-date period in 2010. Orders rose sharply—nearly 300 percent—in the third quarter of 2011 compared to the second quarter. Boeing’s total sales were up 8 percent for the quarter and up about 1 percent year-to-date 2011 compared to the same period in 2010.”

So what does the aerospace industry expect in 2012? “On the one hand,” Chadwick said, “the market for new, large civil aircraft is very healthy over the long term. Boeing’s global forecast reports that global air traffic is projected to grow at above the historical rate through the middle of the next decade, requiring some 33,500 new aircraft by 2030. However, oil prices, the largest single cost for air carriers, along with a weak economy are clouds over the short term.”

On the military side of the industry, “there’s a lot of uncertainty over the future of the Department of Defense budget,” said Fred Downey, AIA vice president of national security. “The defense budget has already been cut and defense will likely have another $460 billion in cuts over the next 10 years, a combination of Budget Deficit Reduction Act-mandated reductions and Pentagon efficiency initiatives,” he said. “What is unclear at this point is whether even more cuts loom. We do not know what the super committee final report will recommend, how Congress will respond and how longer term efforts to balance our fiscal house will affect the industry.”

Manufacturing Risks Ahead

A recent survey from The Manufacturers’ Alliance/MAPI noted that its September composite index fell “only slightly,” to 67 percent from 68 percent in June (see Figure 3, online version). Like other such surveys, above 50 percent indicates expansion in plant utilization. “This quarter’s (the third) survey results point to continued growth, but at a slower rate,” said Donald A. Norman, MAPI economist and survey coordinator. “The forward-looking indexes came in at relatively high levels. Despite the fact that a number of indexes fell, taken together, the results of this quarter’s survey contradict the view that the manufacturing sector is sputtering.”

Other surveys reflect both less and more optimistic descriptions of manufacturing activity. The ISM Manufacturing Index from the Institute for Supply Management improved to 51.6 in September from 50.6 in August, indicating expansion.

“Production and employment both improved,” said Nigel Gault, chief U.S. economist for IHS Global Insight, Northville, Mich. “The orders index was unchanged, but was below 50 (indicating a decline) for the third month in a row. Order backlogs fell sharply. However, price pressures were little changed, remaining far less severe than earlier in the year.”

The plant utilization numbers remaining in the expansion category are good news, but the softness in orders is a concern. “We would have greeted this report with enthusiasm if the headline index had been driven higher by a bounce in new orders,” Gault said. “But the good news was concentrated in production and employment, which are more backward-looking indicators. The most forward-looking component, new orders, remained below breakeven, and order backlogs fell sharply. This suggests future production will be at risk if orders do not pick up.”

So, while manufacturing in general seems to have some sluggish growth issues, some sectors are as robust as they have been in years. Similar to aerospace, solid economic growth was expected for the rest of 2011 and 2012 by participants at the Federal Reserve Bank of Chicago’s annual Automotive Outlook Symposium in June.

The symposium participants, including representatives from the auto industry and analysts, produced a forecast for the rest of 2011 and next year. Their prediction for this year was a slightly lower growth rate by the end of the year compared to 2010, while 2012 will “edge higher, with inflation easing and the unemployment rate continuing to head lower. Real GDP, after having increased 2.8 percent last year, is forecast to rise by 2.6 percent this year and 2.9 percent in 2012.”

Production’s Strong Pace

Perhaps most encouragingly, the Automotive Outlook Symposium report stated industrial production is forecast to increase at a strong pace by the end of 2011 and in 2012. Specifically in the automotive sector, the report indicated that car and light truck sales are projected to improve in 2011, with sales of 13.2 million units; and they are expected to improve to 14.4 million units in 2012.

In a later report, the bank noted that the manufacturing sector, for which the level of production fell by more than 20 percent during the Great Recession, “has been increasing rapidly since the end of the recession. From June 2009 through May 2011, manufacturing output grew at an annualized rate of 6.6 percent, recovering just over half of the loss experienced during the downturn.”