News Analysis

The Factory Rebound May Be Peaking


What may be one of the only clear bright spots in the U.S. economy—the manufacturing sector—continues to shine. That's the first impression from early second-quarter results from industrial barometers like aluminum producer Alcoa (AA), railroad CSX (CSX), and trucker YRC Worldwide (YRCW).

But investors worry whether the success in 2010's first half will continue for the rest of the year.

Alcoa's revenues rose 22 percent from a year earlier, and Chief Financial Officer Charles D. McClane Jr. told analysts July 12 one reason is "continuing improvement in our key end markets."

Transportation companies are a key gauge because they stitch together the rest of the industrial economy. "An improving economy helped almost all the markets we serve rebound from the lows experienced last year," CSX Chief Commercial Officer Clarence W. Gooden told analysts July 13. The company's sales also rose 22 percent from a year earlier.

"The industrial sector experienced significant growth due to increased auto sales and an improving economy," he added.

YRC Worldwide said July 12 that from the first quarter of 2010 to the second quarter, the daily tonnage carried by its trucks was up 11 percent in its national business and up 15.2 percent in its regional business.

Recovery Concerns

The industrial sector of the Standard & Poor's 500-stock index rose 1.9 percent on July 13, but the sector is still off 13.4 percent from its recent peak on Apr. 29. The market has suffered from "concern among investors that the recovery was indeed slowing," Morgan Keegan transportation stock analyst Art Hatfield wrote in a July 8 note. Some economic data, especially housing data and retail sales, weakened in May and June, though there are fewer signs of a sharp slowdown among manufacturers.

One important measure, the Institute for Supply Management's U.S. manufacturing index, hit a recent high of 60.4 in April before moderating to 59.7 in May and 56.2 in June. However, any reading over 50 indicates the manufacturing economy is expanding.

Fastenal Co. (FAST), a seller of industrial and construction supplies, said July 13 that last quarter's sales rose 20.3 percent from a year earlier. "May was just a spectacular month," Chief Executive Officer Willard D. Oberton told analysts July 13, adding "we're not at all disappointed with June."

But can the industrial expansion can continue?

CSX's Gooden said July 13 that "the macroeconomic recovery which began in late 2009 is expected to continue throughout this year." He told analysts to expect U.S. industrial production to grow more than 3 percent in the second half of 2010.

Challenging Trends

Despite that optimism, many executives are expected to be cautious about predicting economic trends. Many transportation companies have stopped giving guidance or predictions about the future, Hatfield wrote, "given the large degree of uncertainty in the economic and freight markets."

The same trends that weigh on the broader economy also could hurt manufacturing. High unemployment, a weak housing market, and high levels of debt are dragging on the economic rebound, says Terry Morris, senior equity manager at National Penn Investors Trust Co. "We are recovering. It is for real," he says. "But there will be a lot of disappointments along the way."

One disappointment for manufacturers could come from the strengthened U.S. dollar, says Michele Gambera, head of quantitative analysis at UBS Global Asset Management (UBS). The pricier U.S. dollar—up 12.6 percent against the euro since the start of 2010—makes U.S. goods more expensive, and thus less competitive, overseas.

Despite strong results, industrial executives acknowledged the challenges ahead. "While many markets are up significantly year-over-year, let's remember that these improvements are relative to a very weak period in 2009," Alcoa's McClane told analysts.

A year earlier, in June 2009, U.S. capacity utilization—the percentage of factory capacity in use—hit an all-time low of 68.3 percent. The measure's most recent reading, in May 2010, was 74.1 percent.

Demand Outlook

To keep the industrial recovery on track, "we need corporate spending to continue," Gambera says. Two other drivers of manufacturing demand—the replenishment of inventories and exports—seem to be tapped out, so companies must feel the need to replace aging equipment, he says.

A recent survey of trucking companies by Longbow Research showed that, while 93 percent of those surveyed said demand was up from a year earlier, many operators differed about prospects for the rest of the year.

A crucial month could be August, when trucking's busy season usually starts, Longbow analyst Lee Klaskow wrote July 12. "If demand picks up in early August, it could mean a longer, more robust peak season lasting through Thanksgiving," he said. "A late August start, meanwhile, typically predicts an early end to trucking's busy season, perhaps in late October."

Factories, warehouses, and truck and train depots are humming now. But investors still have reasons to worry that economic activity will trail off as the summer passes and the holiday season approaches.

Steverman is a reporter for Bloomberg News in New York.

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