Industrial Manufacturers Uncertain About The U.S. Economy – See Growth Potential Abroad.

PricewaterhouseCoopers’ Manufacturing Barometer shows that nearly half of industrial manufacturers are uncertain about the domestic economy’s prospects over the next 12 months. However, more than half are optimistic about the world economy, and the majority expect robust revenue growth, major investments and new hires over the next year.

Fifty-four percent are optimistic about the world economy, a jump from 46 percent in the prior quarter, but still substantially lower than the 68 percent of a year ago. However, fewer than half of the respondents, 45 percent, are now optimistic about the U.S. economy over the next 12 months, down from 54 percent last quarter and 71 percent in the first quarter of 2005. (This is the first time since the Q2 2003 Barometer that optimism dipped below 50 percent.)

Energy prices continue to be a concern with 80 percent anticipating that escalating energy prices will prove a potential roadblock to growth of their company over the next 12 months, up from 53 percent last quarter. Increasing interest rates (cited by 25 percent, up 9 points) are a growing concern as well.

“A combination of uncontrollable factors dampened the outlook for the domestic economy in the third quarter, including the effects of two devastating hurricanes, energy prices that reached new highs and rising interest rates,” said Jorge Milo, leader of PricewaterhouseCoopers’ U.S. Industrial Manufacturing Practice. “In the U.S., some have suffered lost markets, damage to operating capacity, and reduced profitability. But, these problems are being offset by opportunities abroad.”

In fact, 37 percent of those surveyed have manufacturing operations in China, and another 5 percent plan to begin manufacturing there within the next 12 to 18 months. Of this 42 percent, eighty-five percent say that manufacturing in China will be important to the profitable growth of their company over the next three to five years.

“China plays an increasingly important role in terms of growth opportunities for industrial manufacturers,” said Milo. “While there are a number of opportunities in this market, there are also major challenges that need to be managed.”

Those surveyed expect that there will be challenges to manufacturing in China that may not be present in other overseas operations, including: protecting intellectual property assets (63 percent), compliance with local regulations and laws (52 percent) and attracting, motivating and retaining employees (48 percent). Managing local client relationships (37 percent), taxes and transfer pricing (33 percent), country risks and cash repatriation (33 percent) and managing IT investments (15 percent) are also challenges associated with manufacturing in China.

In addition to opportunities abroad, the survey also shows that manufacturers are optimistic with respect to revenue growth and new investments in the next 12 months.

Industrial manufacturers expect revenue gains averaging 7.8 percent over the next 12 months – well above the 6.5 percent estimated in the prior quarter – but still below their ambitious goal of 9.0 percent, set a year ago.

Additionally, 60 percent plan to make major new investments of capital (which is up from 42 percent in the prior quarter and exceeding the 56 percent of a year ago). Investments are expected to average 8.0 percent of revenue, similar to the prior quarter.

The survey also shows a slight improvement in gross margins. In Q32005, costs were higher for 57 percent of those surveyed, and lower for 21 percent. Nearly half, 48 percent, increased their prices, while only 14 percent lowered them. In the process, 38 percent increased their gross margins, while 26 percent had a decrease, for a net of 12 percent showing improvement. In the prior two quarters, the net was flat or slightly negative. Overall, only 26 percent cite decreasing profitability as a potential barrier to their company’s growth over the next 12 months.

“When faced with escalating costs, these companies are doing better than just holding their own,” said Milo. “In an environment of uncertainty, they are expecting solid revenue growth, and their margins are improving.”

One area, however, in which industrial manufacturers expect cutbacks is in hiring plans. Fifty percent plan to increase their workforce, up from 43 percent in the prior quarter, and 41 percent a year ago. But, as a group, industrial manufacturers expect the size of their workforce will shrink by an average of -0.5 percent, down from modest growth of +0.6 percent projected last quarter.

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