2007: not for the faint hearted

Mining related companies aside, Australia's manufacturing industry has battled through 2006 counting on the relentless pressures on costs to somehow ease. But as Alan Johnson and Derek Parker report, the world of increased competition coupled with razor-edge margins look set to continue.

Mining related companies aside, Australia’s manufacturing industry has battled through 2006 counting on the relentless pressures on costs to somehow ease. But as Alan Johnson and Derek Parker report, the world of increased competition coupled with razor-edge margins look set to continue.

MANUFACTURERS hoping 2007 will be the light at the end of the tunnel appear destined for another year of disappointment, with increased global pressures and a subdued domestic economy.

There are exceptions of course, but any reader who thought 2006 was tough should ready themselves for much of the same.

The latest IBISWorld 2005/06 data on the top 100 manufacturers portrays just how difficult it has been over the past year or so…..but would have been even worse if SMEs were included in the ranking.

While the data supplied shows revenue rose 11% in the past year or so for the top 100 manufacturers, this contradicts with ABS data on all of the manufacturing industry, which reported sales rose by only 5.9% in 2005/6. Even with an 11% revenue growth, profits overall were a disappointing -3%, and that’s including figures from manufacturers close to the booming mining industry such as Gold Corp (profits up 132%), United Group (up 78%) and Zinifex (up 61%). Not surprisingly the top three companies, Caltex, Shell and BP, are from the petroleum ‘club’.

According to Graeme Billings, head of PricewaterhouseCoopers’ industrial products division, there is still significant activity at the top end of town. “There’s a lot of private equity money out there and we’re seeing it in a number of sub sectors, including manufacturing. But because there’s so much cash out there for possible takeovers and private equity deals, access to cash will have a big bearing on some of these companies.

“But if you look at the profitability levels of some of the key manufacturers across Australia, it has been pretty flat; apart from the resource industry obviously,” Billings told Manufacturers’ Monthly.

Heather Ridout, CEO of the Australian Industry Group, described 2006 as a “difficult mix of cyclical and structural conditions”.

“The strong dollar is exacerbating the loss of domestic and export market share to lower cost international competitors, particularly China. It is also contributing to an intense wave of restructuring and greater offshoring of lower value-adding activities.

“At the same time, there has been little relief from supply-side pressures, particularly cost increases and skill shortages.

“The combination of more comfortable inventory levels, a patchy recovery in the housing sector, and a stronger export performance appears to have underpinned a tentative recovery in domestic manufacturing activity in the second half of 2006,” Ridout told Manufacturers’ Monthly.

However, Ridout is not convinced the recovery is sustainable. “There are signs these structural and cyclical pressures are easing. And with domestic conditions under further pressure from rising interest rates, next year promises to deliver much of the same as in 2006,” she said.

According to Ridout, the first half of the year offers the brightest prospects for local manufacturers, “hinging largely on the continuing strong growth in construction sector activity”.

Ridout believes a recent moderate upturn in dwelling approvals should help extend the pipeline of residential construction activity into the first half of 2007, “while mining and public sector infrastructure investment is again forecast to grow strongly in the 2006/07 financial year”.

Moving into the second half of the year, however, Ridout predicts higher interest rates will largely offset the positive effects of undersupply in the national housing market, “while growth in mining sector and other infrastructure investment is also likely to be slowing,” she said.

On the positive side, Ridout is predicting a moderate strengthening in exports in the second half of 2006. “It will be important to assess whether this upturn reflects the positive impact of industry restructuring and improved productivity, including a stronger focus on innovation, greater efficiencies in production and integration into global supply chains, or some other factor.

“A further important issue likely to affect Australian manufacturing next year will be the success or otherwise of efforts to slow and rebalance Chinese economic growth, and the need to avoid over-investment in Chinese industrial capacity.

“Excess capacity, coupled with an undervalued Chinese currency, the Renminbi, could result in downward global pressure on manufactured goods prices and manufacturing profitability,” Ridout said.

Billings agrees manufacturers have had a pretty tough time in 2006. “There have been a number of issues that they have been dealing with for a couple of years, but have really kicked in this year. Issues like rising input costs, the whole up-skilling issue and development of skills, the price of fuel.

“The whole area of labour, the need to invest in new technology to keep pace with the rest of the world and the impact of China has really kicked in.

“The amount of activity China has taken away from the Australian manufacturers is significant.”

Billings estimates the net impact has been a loss of about $800m of sales in ’05/06 alone.

However he says manufacturers are not ignoring China, or the rest of the world. “There’s been a massive realisation that Australian manufacturers need to think global.

“That’s what’s driving … or should be driving the majority of manufacturers,” Billings said.

“Companies will continue to focus on restructuring their businesses to align themselves with the globe and what’s happening there, such as global supply chains and offshoring of some of their more low value add products.

“However, quality decisions have to be made when offshoring, as well as logistics and the supply chain to make sure there’ll be enough product coming through at the right time. They would be doing themselves an injustice if they didn’t look at offshoring.”

Billings sees no slowing of China’s growth, expecting its GDP to continue growing at around 8% to 9%.

Ridout believes the challenges facing Australian manufacturing are going to grow as China’s industry moves up the technology spectrum. “Indeed it’s already making leaps in automotive, steel products, home appliances, electronics, office machinery and a range of other areas.

However Ridout suggests manufacturers can minimise the impact by building exports to China, relocating production close to growing Chinese cities and making greater use of Chinese supply chains.

“Making more use of the market opportunities that China offers must be part of our response, but without a concerted focus on developing new products and innovation generally, Australian manufacturing will face increasingly stiff competition,” Ridout said.

But any FTA with China, according to Billings, is a long way off.

“I don’t expect to see anything finalised for a good two years. Negotiations will continue, but there’s a lot of scepticism out there about free trade agreements.”

However when it comes to manufacturing input costs, Billings expects there will be some limited relief.

“While interest rates will increase in the short-term, they may level-off or even come down a bit, meaning the Aussie dollar will be impacted both positively and negatively on that.”

When it comes to raw materials Billings expects copper and aluminium prices to fall in ’07, but for nickel, a key ingredient in stainless steel, he predicts prices to remain high, as well as zinc.

On the all important oil prices, Billings expects them to level-off a bit, and may even decrease in the latter half of ’07. “That’s what the stats are telling me, with plastic to follow oil,” Billings said.

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