Manufacturers Belie Slowing Pace - Apr 15 2005

Capital Goods Sell Briskly,But Consumers' DemandFor Autos, Furniture Drops
By TIMOTHY AEPPEL Staff Reporter of THE WALL STREET JOURNAL
Evidence of declining consumer demand keeps mounting, even amid upbeat economic developments.
Major U.S. manufacturers, despite high energy and raw-material costs, are continuing to see firm growth in orders, aided by the weaker dollar and the continuing move to replace equipment bought during the investment boom of the 1990s.
The strength is visible more among capital-goods producers and less among consumer-oriented manufacturers. Furniture makers and others in the latter category are seeing the impact of slowing job growth, a decline in consumer confidence and low household savings rates. Indeed, noticeably absent from the rosy projections are auto makers and their suppliers, who have cut expected profit and production plans.
At the same time, U.S. business inventories rose in February, expanding 0.5% to a seasonally adjusted $1.288 trillion, while sales fell 0.4%, the steepest decline since April 2003, the Commerce Department said yesterday.
Combined with the reports earlier this week of a record February trade deficit and disappointing March retail sales, the data added another indication that America's 2005 economic growth may be weaker than the gradual slowing many economists have anticipated from last year's 4.4% pace.
Meanwhile, a top Federal Reserve official said yesterday that persistently high energy prices may finally be taking a toll on consumer spending, though economic growth should remain solid.
"Increases in energy prices are siphoning purchasing power of both households and businesses" to foreign oil producers, leaving less money for domestic purchases, Federal Reserve Governor Donald Kohn said. While last year's rise in energy prices only damped spending to a "limited extent," the "persistence of higher prices may have a cumulating effect on spending, early hints of which might now be showing up in the latest reading on retail sales."
The bright spot for manufacturing appears among companies that feed off the heavy-equipment market, from tractors to railcars and trucks, as well as defense, aerospace and automation. There, the outlook remains strong in large part because of the rush to replace machines bought during the technology boom.
"Those things are all five, six, seven years old and are coming up for replacement," says Jim Meil, chief economist at Eaton Corp., of Cleveland. "That's sustaining pretty strong domestic demand." Yesterday, Eaton said its first-quarter profit rose nearly 40%, aided by surging sales of electrical equipment, and it expects the second quarter to beat the year-earlier period.
Likewise, Al-Jon Inc., a heavy-equipment maker in Ottumwa, Iowa, is at maximum production, making machines that crush cars -- a business that has boomed with demand for scrap metal around the world -- and giant machines that compress waste to make more space in landfills. The company's order books continue to grow, and it now expects to finish this year with record sales of $40 million, $5 million higher than last year.
Kendig Kneen, Al-Jon's president, says he has been able to pass through higher steel prices on machines for the scrap-metal industry, but not as much on trash compactors.
"While there are concerns about the impact of higher oil prices -- and higher prices for other commodities -- the general view is that these are going to moderate," says Donald Norman, an economist with the Manufacturers Alliance/MAPI, an Arlington, Va., research group.
Mr. Norman surveyed 67 of the nation's largest manufacturing companies and found that executives expect new orders, investments and profits all to remain at high levels by historic standards. For example, the vast bulk of respondents, 85%, said they expect new orders to be higher for all of 2005, compared with last year, while 55% expect investment to increase, compared with last year. Those comparisons are particularly significant, since last year was such a strong year for manufacturers.
Many manufacturers also are benefiting from the dollar, which, despite hitting a two-month high yesterday against the euro, remains relatively weak. When the dollar weakens, profits earned overseas by U.S. producers translate back to dollars at a higher rate, and producers in the U.S. are better able to compete against certain foreign producers, both at home and abroad. The weaker dollar has boosted exports for capital-goods makers such as Deere & Co. and Boeing Co.
Companies such as Navistar International Corp. are even facing parts shortages in the face of booming demand for more trucks and buses. The Warrenville, Ill., truck and bus maker yesterday reported first-quarter net income of $20 million, or 27 cents a share, compared with a loss of $14 million, or 20 cents a share, a year ago. It said it doesn't expect the parts shortages to hurt 2005 earnings.
Daniel Ustian, chairman and chief executive, says he expects business to remain strong for at least the next 12 to 18 months. The backlog of orders for the company's heavy trucks is up 40% since December, and it is expanding capacity to produce a wider range of diesel engines.
The Commerce Department report on inventories offered some room for optimism. The February business inventory-to-sales ratio rose to 1.31 from 1.30 the previous month. The ratio was at 1.33 in December. The gauge refers to how many months a business would need to sell all current inventory.
"It looks as though we've made a turn on the inventories-to-sales ratio. And with the auto sector cutting back, that is probably going to ripple through other parts of the economy and lead to a lower desired level of inventories," said Paul Kasriel, chief economist with Northern Trust in Chicago.
Mr. Kohn, the Fed governor, told a meeting of directors of the Federal Reserve Bank of San Francisco that the "economy is likely to remain on a path of solid growth," thanks to steady job growth, rising business confidence and still-low interest rates.
The Labor Department reported yesterday that the number of U.S. workers filing first-time applications for unemployment benefits fell last week to a three-week low. Initial jobless claims fell by a seasonally adjusted 10,000 to 330,000 in the week ended April 9, the department said.
The four-week average, which smooths out weekly fluctuations, rose slightly to 338,000. Economists say averages below 350,000 typically indicate net job creation.
Mr. Kohn also said inflation still is contained, thus "our best guess, for now," is that interest rates will rise at a "measured" pace. "Measured" has come to mean no more than a quarter percentage point a meeting.
There are "hints inflation pressure may be intensifying," he noted, but by citing restraints on growth such as high energy prices, he suggested he saw little urgency to move from quarter-point to half-point rate increases for now.
He indicated, however, that the "measured" pace may be abandoned without notice. The Fed's verbal guidance, he said, "cannot and will not deflect us from changing our strategy whenever we believe doing so to be necessary to meet our objectives."
--Campion Walsh and Joseph Rebello of Dow Jones Newswires contributed to this article.
Write to Timothy Aeppel at timothy.aeppel@wsj.com