Taking Cover in a Trade War

With Donald Trump kicking sand in the faces of our trading partners, the days ahead seem destined to be tension filled.  Threats of tariffs back and forth across oceans are sending shock waves through the complex supply chains that make up modern commerce.  Virtually all companies are vulnerable at some point in their supply to higher prices or worse yet subject to reduced demand in their distribution channels.

Investors need a place to take cover. Which U.S. sectors are least exposed to foreign sourcing?  least dependent upon foreign buyers?

The 2017 report, “Making it in America:  Revitalizing US Manufacturing”, from the consulting firm McKinsey & Company provides insight into the sectors most dependent upon trade.  McKinsey’s analysis suggests fabricated metal, rubber and plastic products are the least sensitive to import-export activity, while basic consumer goods and tech-driven products such as computers and electronics are dependent upon global trade.  This analysis may be too shallow for an investment decision.

These questions can be answered at least in part by dusting off an oldie but goodie from the U.S. Department of Commerce.  In 2014, the DOC published a paper “What is Made in America?”, updating it in March 2017 with data through the end of 2015.  The paper was aimed at determining the domestic share of U.S. gross output of manufactured goods.  The conclusion was that in 2015, 82% of the value of goods produced by U.S. manufacturers consisted of domestic content.  While that ending point might not answer our investor question today, the exercise provides some helpful insight.

As a whole the U.S. manufacturing complex used 18% foreign content to product gross output in 2015.  The rest of the gross output value was 46% domestically sourced inputs and 36% value-added in the production process.  The DOC report provided a breakdown of domestic and foreign content for nineteen industries.  Nonmetallic mineral products led all sectors with 90% domestic content as would be expected of a commodity extracted from domestic sites.  However, computer and electronic products was in a surprise tie at 90% domestic content.  This was due in part to advanced technology applied in the U.S. related to artificial intelligence, robotics and augmented reality.  A close runner up to the two was the chemical product sector using 88% homegrown supplies and beating out the localized food and beverage sector with its 87% domestic content.

Independence from a foreign supply chain is not enough given that reaction to Trump’s proposed tariffs from both China and the European Union has been a long list of retaliatory tariffs.  Thus not only will foreign-sourced content cost more, there is a good chance that some demand will be extinguish for a U.S. produced product.  Thus investors must also look for a sector that is not dependent upon exports.

According to the CIA World Factbook, about 12.2% of U.S. goods and services output is sold to foreign buyers.   In 2017, exports totaled $1.5 trillion dollars or about $4,700 for each U.S. citizen.  That was a 6.6% improvement over the previous year, but still lower than 2013 at the beginning of the recovery from the Great Recession.  It suggests that the U.S. is among the countries least vulnerable to a trade war  -  at least from perspective of selling U.S. goods. 

That does not mean that particular industries within the U.S. are not vulnerable in a trade war.  As discussed in the previous post, “U.S. Chemical Industry Export Surplus Under Threat,” the chemical industry is highly dependent upon trade, exporting as much as 21.5% of the sector output in 2017, according to the U.S. Bureau of Economic Analysis.  However, it is the automotive sector that has shareholders looking for options insurance.  Motor vehicles, bodies and trailers along with parts exported 36% of output in 2017.  In large part exports support assembly and finishing work at factories located in other countries.   

At least 35% of other transportation equipment, such as aircraft, is also shipped to customers outside the U.S.   Indeed, Boeing (BA:  NYSE) is the largest exporter in the U.S. and has already been informed of a 25% tariff imposed by China on Boeing’s 737 passenger jets.  The tariff could render Boeing uncompetitive in China, which represents the largest single market for aircraft.

Yet, in the manufacturing sector there are several sectors than export only a minor portion of their finished products to foreign buyers.  The U.S. furniture industry is the least dependent on foreign trade, exporting only 5.8% of total output in 2017.  Wood, nonmetallic mineral products, and fabricated metal products are also mostly sold domestically with less than 10% of output sent out of the country.  Of course, these figures can be misleading given that output and export data focus on the producer itself, ignoring the downstream supply chain.  Distributors who buy these products wholesale may very well have significant business outside the U.S.,  in which case the producer would still be vulnerable to reduced demand that comes with tariffs.

Are wood and fabricated metals companies a safer haven for investors compared to other higher profile exporters?  The supply chains in these sectors may not be subject to pricing pressure from U.S. tariffs and they would lose less demand even if the Chinese or the Europeans were to retaliate with tariffs of their own.  A good share of the companies making useful products from wood and metals are private companies, but a few small- and mid-cap companies are earnings strong profits and excellent returns on equity.  Most compelling for investors looking a haven from trade war talk are the strong growth rates projected by analysts following these companies.  Compared to the average price ratio of 18.1 times forward earnings for the S&P 600 Index, the group looks attractively priced as well.

  

Wood and Fabricated Metals Sector
Company	Symbol	TTM Revenue	Operating Margin	Return on Equity	Growth Rate	PE
American Woodmark	AMWD	$1.25 B	8.6%	13.5%	8.0%	11.7
Core Molding Technologies	CMT	$188.0 M	4.5%	4.2%	na	26.5
DMC Global	BOOM	$221.2 M	9.3%	neg	20.0%	17.2
Masco Corp.	MAS	$7.8 B	14.9%	nm	19.1%	13.0
Norcraft Companies	Private	na	na	na	na	na
Patrick Industries	PATK	$1.84 B	7.6%	28.0%	14.3%	12.1
Silvan Forest Products	Private	na	na	na	na	na
Sg Blocks	SGBX	$5.1 M	neg	neg	na	na
Trex Company	TREX	$591.6 M	25.1%	49.3%	25.0%	27.3
Universal Forest Products	UFPI	$4.09 B	4.5%	14.2%	11.5%	13.5

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.