The Cornucopia-of-Cash Dilemma in a Capacity-Challenged Economy

Nov 27, 2015

For many firms with an industrial or engineering bent, a prime driver of construction spending plans is their sector’s capacity utilization rate.

2015 11 26 US Oil Capacity Graphic

The capacity utilization rate is defined as the ratio of actual output to estimated potential output. The latter is based on standard operating conditions; not what could be achieved by means of extraordinary overtime efforts.

Once the usage rate of a sector rises above a certain benchmark level – over 80% and probably nearer 85% − a single trend-setting firm will decide to take the investment plunge.

Competitors will often jump on the bandwagon as well, in what might be termed a ‘copycat effect’.

At least, the foregoing describes what happens in a normal business cycle, as activity levels first recover from recession, then launch into unexplored frontiers.    

Table 1, which accompanies this Economy at a Glance, shows that quite a number of the major industrial sectors in the U.S. and Canada aren’t at that point yet.

Furthermore, several of them may be stepping back from the 85%-line in the sand.

Table 1 shows capacity utilization rates for eight key sectors in the U.S. and Canada, along with quarter-to-quarter and year-over-year percentile changes.

An increase in the percentile change is shaded in red; a decrease, in blue. The former is positive for construction prospects; the latter, negative.

There are 17 possibilities in each of the two right-hand columns.

With respect to the year-over-year results, there are 12 percentile decreases and only five (i.e., less than half as many) increases.

As for the latest quarter-to-quarter findings, the results are even more lopsided: 14 subtractions; only two additions; and one flat outcome (for U.S. wood products). 

In other words, blue shadings heavily predominate over red ones.

At present, America’s economy is clearly growing faster than Canada’s.

In fact, Canada recorded two consecutive quarters of negative ‘real’ (i.e., adjusted for inflation) quarter-to-quarter annualized gross domestic product (GDP) change in 2015’s first half.

Nevertheless, according to the numbers calculated by Statistics Canada and the Federal Reserve, both total industry and manufacturing in Canada, at 81.3% and 81.9% respectively, are operating closer to capacity than their counterparts south of the border, at 77.5% and 77.0% respectively.

There are some notable statistics mixed in with the overall results in Table 1.

While down from 98.3% a year ago and 96.6% in July, U.S. oil and natural gas firms are still operating at 91.9% in the latest month, October.

This indication of ongoing tightness is despite the dramatic drop-off in the world price of oil. It suggests the hydraulic fracturing sector has not yet pulled up stakes and run off to lick its wounds – although there is no doubt that upstream capital spending has been in freefall.

Canada’s oil and gas extraction sector has eased back to a still-high 84.7% usage rate in the latest quarter from 87.9% in Q1 and 87.7% in Q2 of last year.

U.S. electric power generation is currently operating at 77.3% of capacity. For the same sector in Canada, the figure is a more fulsome 85.6%. The fall of this year has seen a construction start on B.C. Hydro’s mega-sized Site-C dam and generation project on the Peace River.  

The most dramatic disparity between the two countries is found in the ‘wood products’ sector.

Firms making plywood and other sawmill products north of the border are operating at 96.5% of capacity.

Meanwhile, the usage rate of their brethren south of the border is only 69.9%.

Many firms have accumulated stockpiles of cash from profits earned since the Great Recession. What are they to do with this bounty, if they’re not spending it on new physical plant?

As Graphs 1 and 2 illustrate, the number of sub-sectors that have reached that threshold remains limited.

Graph 1 shows that there are only two sub-sectors among American manufacturers of durable goods that are currently operating with capacity utilization rates in excess of 85.0%: assemblers of light motor vehicles (88.1%) and producers of electrical equipment and appliances (87.4%).

There are no U.S. manufacturers of non-durables that have climbed above the 85.0% usage-rate shelf.

Not appearing in the graph, but included among the tables at the Federal Reserve’s website, is a figure at the extreme opposite end of the spectrum.

The difficulties currently being experienced in the oil patch are the explanation for why the sub-sector designated as ‘support activities for mining’ is currently operating at only 35.5% of capacity. The comparable figure at the same time last year was 68.2%.

In Canada, there is a slightly longer list of sectors operating above 85% of capacity. Among durable goods manufacturing are wood products (96.5%) and transportation equipment (90.2%).

Among non-durable goods manufacturing, in the land of maple leaves and Mounties, are paper (93.8%) and textile mills (87.8%). The producers of rubber products (84.8%) didn’t quite make the cut. (The rubber products sector is benefitting from strong motor vehicle sales, both domestically and in the U.S. export market.)

For both the U.S. and Canada, the Great Recession ended in mid-2009. During the intervening seven years, quite a number of firms have been stockpiling sizable profits.

If they’re not yet seeing the need to add to their facilities, what are they to do with their cornucopias of cash?

One readily apparent response has been a tidal wave of mergers and acquisitions (i.e., M&A activity).

Just last week, the Marriott International accommodation chain, in a deal worth more than $12 billion, brought Starwood Hotels and Resorts under its awning.

The former, besides its namesake brand, includes Ritz Carlton. The latter encompasses the Sheraton, Westin, ‘W’ hotels, St. Regis and Le Méridien properties.

The combined entity will have 1.1 million hotel rooms in over 100 countries.   

In the railroad sector, Canadian Pacific Ltd. (CPR) is making a bid, valued at $28.4 billion, for Norfolk Southern Corporation. This would add valuable and currently missing track capacity in the U.S. southeast to CPR’s assets in the north and middle of the country.   

It might also lead to an easing of congestion at Chicago’s notoriously inefficient railroad hub.  

CPR is dear to the hearts of Canadians for the leading role it played in linking the country from coast to coast in the late 1800s. The ‘last spike’ heroics of the businessmen and politicians who steered the project through to its successful conclusion are taught to all school children.

The company is currently headquartered in Calgary. There has been early speculation that a marriage might result in a head office relocation to Virginia. No amount of attempted finesse by a public relations firm will mute this shock to the Canadian psyche.

Norfolk Southern has expressed little enthusiasm for being courted in such a manner.

The sums mentioned so far are paltry when compared with several other hook-ups this year.

Double the figure and you have the $50 billion spent by John Malone’s Charter Communications to gain control of Time Warner Cable.

Also at a tally of $50 billion, Heinz Corporation has purchased Kraft Foods. The new Kraft-Heinz union is notable for the guiding partnership of two of the world’s best-known billionaire moguls, Warren Buffet of Berkshire Hathaway and Jorge Paulo Lemann of 3G Capital.

Mr. Lemann has quickly established a name for himself as the richest man in Brazil. He recently appeared prominently in a Bloomberg News magazine devoted to profiling the 50 most influential people on today’s world stage.

Double the number again to $100 billion-plus and you have the amount spent by Anheuser-Busch InBev to woo and win SABMiller PLC. Once again, Mr. Lemann has been the ambitious dealmaker.

The new beer-making giant will include many beverage favorites including Budweiser, Coors and Stella Artois.

Finally, and most recently, there is the biggest takeover proposal of all, Pfizer Inc.’s pursuit of Botox-purveyor Allergan PLC.

How big is Big Pharma? If allowed to proceed, the sum in play will be an astronomical $150 billion.

These deals, judged beneficial from a financial standpoint by their proponents, on account of their potential for lowering costs through better logistics and staffing rationalizations, must win approvals from regulatory agencies that are charged with ensuring the resulting reduced competition won’t harm consumers.

Those are sure some big dollar amounts that are being bandied about.

As the rest of us wander curiously among the gaming tables at the M&A casino, fascinated by the high-rollers with their thick wads of cash, we have to keep in mind that we’re in the presence of a different mind-set.

“Hey, it’s only money.”

Table 1: Capacity Utilization Rates (%)
(Leading indicators for industrial and heavy engineering construction)

Year Ago Quarter Ago Latest Percentile Changes
A B C C vs A C vs B
Total Industry          
U. S. (1) 78.5% 78.0% 77.5% -1.0 -0.5
  (Oct 14) (Jul 15) (Oct 15)    
Canada 82.8% 82.6% 81.3% -1.5 -1.3
  (Q2 14) (Q1 15) (Q2 15)    
Oil & Gas Extraction        
U. S.  98.3% 96.6% 91.9% -6.4 -4.7
  (Oct 14) (Jul 15) (Oct 15)    
Canada 87.7% 87.9% 84.7% -3.0 -3.2
  (Q2 14) (Q1 15) (Q2 15)    
Mining (except oil and gas)      
U. S.  80.0% 78.7% 78.3% -1.7 -0.4
  (Oct 14) (Jul 15) (Oct 15)    
Canada 67.8% 61.0% 58.2% -9.6 -2.8
  (Q2 14) (Q1 15) (Q2 15)    
Electric Power Generation      
U. S. 79.1% 77.2% 77.3% -1.8 0.1
  (Oct 14) (Jul 15) (Oct 15)    
Canada 85.4% 87.2% 85.6% 0.2 -1.6
  (Q2 14) (Q1 15) (Q2 15)    
Total Manufacturing        
U. S. (2) 76.6% 77.2% 77.0% 0.4 -0.2
  (Oct 14) (Jul 15) (Oct 15)    
Canada 82.5% 82.8% 81.9% -0.6 -0.9
  (Q2 14) (Q1 15) (Q2 15)    
Petroleum & Coal Products (gasoline, diesel fuel, aviation fuel, asphalt)  
U. S. 82.2% 84.8% 84.7% 2.5 -0.1
  (Oct 14) (Jul 15) (Oct 15)    
Canada 80.8% 79.8% 80.1% -0.7 0.3
  (Q2 14) (Q1 15) (Q2 15)    
Wood Products (sawmill products, plywood, engineered wood products)
U. S. 72.0% 69.9% 69.9% -2.1 0.0
  (Oct 14) (Jul 15) (Oct 15)    
Canada 89.7% 97.2% 96.5% 6.8 -0.7
  (Q2 14) (Q1 15) (Q2 15)    
Transportation Equipment (motor vehicles, planes, boats, railroad rolling stock)
U. S. 79.3% 96.6% 88.1% 8.8 -8.5
Light Motor Vehicles (Oct 14) (Jul 15) (Oct 15)    
U. S. 78.2% 78.4% 77.9% -0.3 -0.5
Other (airplanes, etc.) (Oct 14) (Jul 15) (Oct 15)    
Canada 92.4% 90.5% 90.2% -2.2 -0.3
All Transport Equipment (Q2 14) (Q1 15) (Q2 15)    


(1) 1972 to 2014 (i.e., long-term) average for U. S. total industry = 80.1%.
(2) 1972 to 2014 (i.e., long-term) average for U. S. manufacturing = 78.5%.
A decline is shaded in blue; an increase is shaded in red.

Data sources: Federal Reserve Board and Statistics Canada.
Table: CMD.

Graph 1: U.S. Capacity Utilization Rates - October, 2015

U.S. Capacity Utilization Rates - October, 2015

Data source: Federal Reserve
Chart: CMD.

Graph 2: Canadian Capacity Utilization Rates - Second Quarter, 2015

Canadian Capacity Utilization Rates - Second Quarter, 2015

Data source: Statistics Canada
Chart: CMD.

Graph 3: Capacity Utilization Rate - U.S. Manufacturing

Capacity Utilization Rate - U.S. Manufacturing

The last data point is Oct 2015.
The Federal Reserve calculates the figure monthly.

Data source: Federal Reserve
Chart: CMD.

Graph 4: Capacity Utilization Rate - Canadian Manufacturing

Capacity Utilization Rate - Canadian Manufacturing

The last data point is Q2 2015.
Statistics Canada calculates the figure monthly.

Data source: Statistics Canada
Chart: CMD.

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