Our position in brief

Contrary to an unfortunate stereotype, U.S. manufacturing is alive and well. The U.S. remains the world’s leading manufacturer. However, among the things that are different about U.S. manufacturing today is that it generates fewer jobs and makes more high-end products than before. Such high-end production plays to the nation’s strengths in sophisticated research and development, engineering, manufacturing, and management; access to raw materials and major markets; proprietary technologies; and infrastructure. Highlighted are a sampling of 15 U.S. companies in the consumer, cyclical, health-care, producer-durables, and technology sectors that we consider world-class manufacturers.

Unless you’ve been lost at sea for decades, you’re undoubtedly familiar with the oft-repeated stereotype that nothing is made in the U.S. anymore. Well, here’s our reaction to that stereotype: balderdash.

Yes, we know the stories about the deterioration of the once-mighty manufacturing bases of cities like Flint, Buffalo, Cleveland, and Pittsburgh -- "names [that] read like tombstones in the graveyard of America’s Rust Belt," says The Economist. Yes, we’ve heard all about how an affluent U.S. can’t compete in manufacturing with low-wage nations like China, India, Taiwan, and Mexico. And yes, we’ve seen the data about how the U.S. ranks behind almost every developed nation in the percentage of overall economic activity devoted to manufacturing. There’s some truth to all that, but it’s hardly the whole truth.

Actually, there’s a lot being manufactured in the U.S. today. The U.S. remains the world’s leading manufacturer by far. Indeed, if the U.S. manufacturing industry were a national economy, it would be the eighth largest in the world, worth $1.6 trillion. The U.S. contributes 22% of global manufacturing output and ranks third, behind Germany and China, as a manufacturing exporter, with an 8.1% market share.

A portrait of growth

Here are a few additional facts, courtesy of the National Association of Manufacturers, that paint a healthier picture of U.S. manufacturing than is popularly supposed -- a picture that conveys vibrancy and growth, not death or decline.

*  U.S. manufacturing exports increased by 60% from 2000 to 2008 (the latest year for which reliable statistics are available). In 2008 manufactured goods accounted for 57% of total exports, compared with only 6% for agricultural goods.

*  In 2008 U.S. manufacturing workers earned an average of $71,623 annually, including benefits. That’s 26% more than the $57,064 that non-manufacturing workers made.

*  U.S. manufacturing workers, equipped with technological tools that are the envy of the world, are the most productive -- 50% more productive than workers in the 11 next-best nations.

One reason why the stereotype of a waning U.S. manufacturing industry has acquired plausibility is that the industry has in fact lost jobs, due partly to the impact of technology. According to a study by Dr. Mark Perry, a professor at the University of Michigan-Flint, technology has enabled manufacturers to make more with less people. In the past 37 years U.S. manufacturing output in inflation-adjusted dollars more than doubled, while U.S. manufacturing employment dropped by more than 26%. Overall, about 12.7 million Americans, or 8% of the workforce, currently hold manufacturing jobs, according to the Associated Press. Fifty years ago 14.6 million people, or 28% of all U.S. workers, were employed in manufacturing.

Services growing faster

In the process, manufacturing’s position in the economy has also diminished. Manufacturing’s share of gross domestic product peaked at 28.3% in 1953 and has been declining ever since, to about 12% today, according to the National Association of Manufacturers. But that doesn’t mean that manufacturing is on its last legs; it’s simply growing less fast than services are. Services are the engine that’s mainly propelling the modern economy. Indeed, the big picture of manufacturing’s economic status in the U.S., as viewed through the long lens of history, is this: just as the agricultural economy gave way to the manufacturing economy in the 19th century, the manufacturing economy has been superseded by the service economy over the past six decades.

The ascendance of the service economy reflects nothing so much as the growth in prosperity in the U.S. As the Cato Institute, a policy-research firm, explains: "A major reason why manufacturing is relatively less important in what Americans produce is that it is less important in what we consume. It appears to be an iron law of human development that, as incomes rise, we spend a smaller share on goods, such as food and manufactured products, and a higher share on services." In the 1950s Americans spent two-thirds of their disposable income on durable and nondurable goods and one-third on services. Since then those percentages have been almost reversed: today a more affluent society spends about 60% on services and about 40% on goods.

As such, we think it’s highly unlikely that manufacturing will again be a wellspring of new jobs in the U.S. -- or for that matter even in emerging nations, which have been anointed by some pundits as The Future of Manufacturing because their rock-bottom pay scales supposedly furnish an unassailable competitive advantage. Just about everywhere in the world, as in the U.S., technology is displacing jobs, and it may very well be that growth in manufacturing employment globally is only modest in the years ahead. However, the manufacturing workers who do have jobs may find they have the opportunity to perform increasingly skilled work at relatively high pay, especially as the median standard of living rises globally.

Changing, not dying

At any rate, it’s simply not accurate to say that manufacturing in the U.S. is dead or dying. More precisely, U.S. manufacturing is changing. Here are three primary ways that we perceive it’s changing:

One, U.S. manufacturing is moving up the value chain, making more sophisticated products that are subject to less foreign competition. It’s been a change driven by necessity. In a survival-of-the-most-competitive business world, it makes sense to manufacture products where they can be produced at the lowest cost. So inevitably some low value-added, commodity products like textiles, toys, and televisions formerly made in the U.S. are now being manufactured in countries where workers earn a fraction of what their U.S. counterparts do.

But low wages aren’t necessarily everything in determining where a product is made now. Manufacturers must take into account a potpourri of other variables as well -- a country’s level of sophistication in research and development, engineering, manufacturing, and management; its access to raw materials and end markets; its degree of legal protection of intellectual property and proprietary technologies; and its quality of infrastructure. And happily for U.S. manufacturers, all of those variables happen to be among their strongest suits.

Going upscale

The U.S. specializes in making products that require a high degree of innovation and technological content, such as computerized industrial equipment, fabricated metal products, drilling equipment, medical devices, chemicals, electronic components, and defense systems. In essence, U.S. manufacturing has gone upscale -- "following the biggest profits and becoming more efficient, just like Henry Ford did when he created the assembly line to make the Model T,"  observes Professor Perry of the University of Michigan-Flint.

Two, in a novel counter-trend, foreign manufacturers are increasingly making things in the U.S. The U.S. accounts for 40% of global demand, and foreign manufacturers are finding it advantageous to establish plants in the U.S. for various reasons: gaining marketing opportunities, earning tax credits, and -- believe it or not -- exploiting certain cost advantages, among others.

A case-in-point: Yuncheng Plate Making of Dongguan, China, the world’s largest manufacturer of gravure cylinders used to print labels on plastic soda bottles, has opened a state-of-the-art plant in Spartanburg, South Carolina. Yuncheng built the plant there because it was economical to do so. The company purchased 6.5 acres of land for the Spartanburg plant for $350,000 -- about 25% of the price of the land in China where three of its existing plants are located. Electricity in the U.S. proved a bargain, too: Yuncheng pays just four cents per kilowatt-hour in Spartanburg, versus up to 14 cents in China.

Cost gap shrinking

To us, Yuncheng’s experience in Spartanburg is yet another confirmation that the sizable gap between manufacturing costs in the U.S. and the rest of the world is beginning to shrink. According to the Rhodium Group, a consulting firm, the lure of prospective cost savings has induced Chinese companies to invest $280 million in South Carolina and nearly $5 billion in all of the U.S. in recent years. If that cost gap continues to shrink, the U.S. should measure up as a more attractive place for business investment by foreign manufacturers. We think the U.S. will be a more appealing investment for Chinese companies, for instance, as China makes good on its promise announced in June to allow the value of its currency, the yuan, to appreciate.

Also, we would never underestimate the power of plain old business pragmatism to motivate foreign companies to manufacture in the U.S. In May, for instance, Anshan Iron & Steel Group announced plans to invest in as many as five U.S. mills in conjunction with a Mississippi company, Steel Development. Initially Anshan will provide $175 million to upgrade a Steel Development plant in Amory, Mississippi, an investment that The New York Times attributed to the company’s desire to "sidestep rising trade barriers." Such a strategy is nothing new. In the 1980s, for instance, Japanese automakers like Toyota Motor encountered an increasingly loud chorus of complaints in Congress about imports to the U.S. and the specter of rising tariffs. In response, Toyota Motor built plants in the U.S. so their cars could be marketed as "Made in America, by Americans." We think foreign companies are likely to seek more of those kind of benefits from "Made in America, by Americans" in the years ahead.

Three, small companies are what’s big in U.S. manufacturing today. The financial problems and massive job losses of the manufacturing titans of old -- Bethlehem Steel, General Motors, Chrysler, et al -- have been chronicled ad infinitum. But what hasn’t been reported as extensively is that for every such large, mature manufacturer that’s struggling or failing, there are many more young, small manufacturers that are flourishing. According to the Cato Institute, for every one U.S. manufacturing industry that’s suffering a decline in revenue and profits, two U.S. industries -- led by small companies -- are growing.

Small: the new model

Small manufacturers like Bien Hecho, of Brooklyn, New York, tend to have the most successful business models today. Bien Hecho (Spanish for "well made") makes $3,000 pine-beam tables for a select customer niche: business offices, restaurants, and wealthy consumers. Bien Hecho and 200 other small manufacturers, most of them with less than six employees, do business in the old Brooklyn Navy Yard on the East River. The New York Times characterized the Navy Yard as "a hothouse for manufacturing entrepreneurs." Demand by entrepreneurs for workspace is compelling the Navy Yard to add 1.5 million square feet in the next two years, the largest expansion there since World War II, the Times reports.

In Detroit, the city that’s synonymous with automobiles, which was a great American growth industry of yore, small machined-parts companies like W Industries are discovering that there’s life beyond the Big Three of General Motors, Ford Motor, and Chrysler. Unlike its bigger counterparts that crank out high volumes of uniform automotive products, W Industries gets customized orders in small batches, such as for steel frames of rough-terrain Army vehicles. To win this and other defense business, W Industries has spent $50 million on modern machinery since 2006. It’s been money well spent: the company’s annual sales have mushroomed from $15 million in 2005 to a projected $150 million this year.

For our part, we in our role as growth investors routinely monitor manufacturing companies of all sizes in the consumer, cyclical, health-care, producer-durables, and technology sectors. For this paper, we thought it would be instructive to identify a few U.S. manufacturers -- 15 companies, to be exact -- that in our estimation possess The Right Stuff: first-rate management, fundamentals, innovativeness, and product quality. Our list, it should be emphasized, is merely a sampling that’s by no means comprehensive; there were scores of good U.S. manufacturers to choose from. The 15 manufacturers arbitrarily cited here met three criteria: 1) they are as representative a cross-section of leading manufacturing companies, with diverse market capitalizations, as we could present within the practical limitations of space in the paper; 2) they are among the market leaders in their businesses; and 3) they do a substantial amount of manufacturing domestically. They are categorized by stock-market sector and alphabetically, as opposed to any subjective order of merit.

Manufacturing leaders in the consumer sectors: A123 Systems, Green Mountain Coffee Roasters, and WMS Industries

A123 Systems (headquarters: Watertown, Massachusetts; market capitalization: about $900 million) uses its proprietary Nanophosphate technology to produce lithium-ion batteries for vehicles, electric-grid systems, and portable power equipment. In our judgment, the company’s batteries should be in much greater demand as the world’s developed nations adopt cleaner forms of energy.

Green Mountain Coffee Roasters (headquarters: Waterbury, Vermont; market capitalization: about $3.5 billion) at its highly automated U.S. plants makes K-Cups, a convenient, popular way to brew single cups of coffee. Sales of the K-Cups have been spawned principally by the best of all forms of promotion: word-of-mouth endorsement by consumers. The company’s sales have grown more than 30% annually over the past three years.

WMS Industries (headquarters: Waukegan, Illinois; market capitalization: about $2.6 billion), with a relentless focus on manufacturing cost-effectiveness, has slashed the time required to make its slot machines and lottery terminals by 78% over the years. The company continues to gain market share in gaming machines in North America and overseas, and we think it can sustain operating margins exceeding 20% for years to come.

Manufacturing leaders in the cyclical sectors: First Solar, Johnson Controls, and United States Steel

First Solar (headquarters: Tempe, Arizona; market capitalization: about $10 billion), the world’s largest maker of thin-film solar modules, is seeking to expand production in the U.S. by more than 30% by 2011. First Solar has the lowest manufacturing costs per watt in the solar-energy industry. The company describes itself as "obsessive-compulsive" about achieving this goal over the next four years: attain price parity in power generation for its products, at 53-63 cents per watt, with conventional fossil-fueled sources of electricity. First Solar was first in the industry to break the $1 per watt barrier in 2008.

Johnson Controls (headquarters: Milwaukee, market capitalization: about $20 billion) makes heating, ventilating and air-conditioning systems for buildings; automotive batteries for conventional, hybrid, and electric vehicles; and automotive-electronic systems. It has been routinely named one of Industry Week’s 50 best manufacturing companies. We think rising automobile production in emerging nations presents a long-term opportunity for a financially strong, well-managed multinational supplier like Johnson Controls to increase its sales and profits.

United States Steel (headquarters: Pittsburgh, market capitalization: about $6.5 billion) is a symbol of Big Steel, of the Gilded Age when industrial tycoons like Andrew Carnegie and John D. Rockefeller transformed the U.S. into the world’s manufacturing colossus. The company has been a leading maker of steel for more than 100 years, and we think this corporate centenarian is still quite spry for its age. In our judgment, United States Steel’s earnings over time should benefit from further industry consolidation, strong demand for its steel tubing by the energy industry, and its moderating costs for employee pensions and health care.

Manufacturing leaders in the health-care sector: DePuy, Stryker, and Zimmer

All three companies -- DePuy (headquarters: Raynham, Massachusetts, and Warsaw, Indiana; a unit of Johnson & Johnson), Stryker (headquarters: Kalamazoo, Michigan; market capitalization: about $20 billion), and Zimmer (headquarters: Warsaw, Indiana; market capitalization: about $11 billion) -- make orthopedic products such as artificial hips and knees. Those products command some of the highest profit margins in the health-care sector. Gross margins for Stryker and Zimmer have averaged more than 65% in the past five years, compared with 59% for medical-equipment companies and 46% for the S&P 500 Index companies, estimates Thomson Reuters.

Also, if familiarity truly does breed contempt, then the three companies might be expected to have developed an utter disdain for each other: all three are cozily engaged in manufacturing in and around Warsaw, Indiana, in semirural Kosciusko County, which prides itself on being "the orthopedic manufacturing capital of the world." An estimated 33% of the $38-billion global orthopedic industry is based in the county, where the three companies provide work for more than 4,000 people, representing about 14% of the area’s private-sector employees.

Sales of the companies’ artificial hips and knees, bone screws, and other devices worldwide have been rising steadily in the 2000s, and we think they should continue to do so. For instance, more than 700,000 hip and knee replacements are performed in the U.S. annually, and we project that the number could double by 2016.

Manufacturing leaders in the producer-durables sector: Caterpillar, PulteGroup, and Varian Semiconductor Equipment Associates

Caterpillar (headquarters: Peoria, Illinois; market capitalization: about $39 billion) is the world’s largest maker of construction and mining equipment, diesel and natural-gas engines, and industrial gas turbines. More than 3 million of Cat’s machines are in use worldwide. We think the company did an excellent job of quickly lowering production levels and costs in the Great Recession and thus is primed to reap ample earnings leverage as the economy recovers.

PulteGroup (headquarters: Bloomfield Hills, Michigan; market capitalization: about $3.8 billion) makes 100% of its products -- homes -- in the U.S. In our judgment, Pulte, as one of the largest builders, enjoys certain advantages of scale: it can negotiate good prices with suppliers, it has diversification in both geography and home models to capitalize on the best markets and particular buyer preferences at a given time, and it routinely achieves a construction efficiency unrivaled in the industry.

Varian Semiconductor Equipment Associates (headquarters: Gloucester, Massachusetts; market capitalization: about $2.4 billion) is a manufacturer for manufacturers: it makes equipment, called ion implanters, used to fabricate semiconductors, the prime component of the Digital Age. The company’s main manufacturing plant is in Gloucester, and more than 70% of its equipment, which we consider the most technologically advanced of its kind, is sold to international customers.

Leading manufacturing companies in the technology sector: Intel, Micron Technology, and Plexus

Intel (headquarters: Santa Clara, California; market capitalization: about $119 billion) has one of the strongest competitive positions in the semiconductor industry, in our view. The world’s largest semiconductor manufacturer, Intel shipped more than 80% of all microprocessors in 2009. Its new high-end Atom chip is highly profitable, with applicability in everything from personal computers to smart phones. Its highly regarded manufacturing methods help Intel to preserve operating margins during the industry’s periodic price wars and expand operating margins during times of rising pricing power.

Micron Technology (headquarters: Boise, Idaho; market capitalization: about $8 billion) has been called the Last of the Mohicans in manufacturing Dynamic Random Access Memory (DRAM) components, which provide high-speed storage and retrieval; that’s because the company is the last American survivor in the DRAM industry, which has been consolidating for years. Standard & Poor’s believes that Micron has "the right technology to compete favorably in the memory market and to reduce cost-per-bit at a fast rate; we think its growth will best that of competitors." Micron manufactures in the U.S. partly to protect the intellectual-property rights of its patented technologies.

Plexus (headquarters: Neenah, Wisconsin; market capitalization: about $1.3 billion) is a leading provider of electronic-manufacturing services, specializing in making low-volume, proprietary products in the U.S. with high profit margins, such as defense avionics, process-control and testing equipment, and wireless routers. The company is winning new business at an accelerating rate. For instance, recently it won 18 new manufacturing projects worth as much as $137 million in revenue annually.

In sum, we think the state of U.S. manufacturing is quite healthy and is likely to remain so for a long time to come. We think that’s good for national security, because the U.S. needs a solid manufacturing base in a world that can be a steamy cauldron of shifting political interests and manufacturing priorities among nations. And we think a solid U.S. manufacturing base is good for the U.S. economy as well, since manufacturing produces more economic activity per dollar of production than any other industry. About one in six private-sector jobs -- a total of 12.7 million manufacturing jobs directly and 6.8 million nonmanufacturing jobs indirectly in industries like accounting, law, transportation, agriculture, and insurance -- depends on U.S. manufacturing.

Altogether, about 286,000 U.S. manufacturing firms exist today. We draw comfort from the prospect that at least some of those 286,000 manufacturers, along with thousands of new manufacturers that may be merely a gleam in an entrepreneurial eye today, should continue to disprove the false notion that nothing is made in the U.S. anymore.       

The views expressed represent the opinions of Turner Investment Partners and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. There can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990, is an investment firm based in Berwyn, Pennsylvania. As of March 31, 2010, we managed more than $18 billion in growth, value, and core stocks in separately managed accounts and mutual funds for institutions and individuals.

As of May 30, 2010, Turner held in client accounts 221,360 shares of A123 Systems, 2.3 million shares of Green Mountain Coffee Roasters, 1.6 million shares of WMS Industries, 4.4 million shares of Johnson Controls, 515,450 shares of United States Steel, 2,010 shares of Johnson & Johnson, 1.7 million shares of Stryker, 140 shares of Zimmer, 2.6 million shares of Caterpillar, 19.2 million shares of PulteGroup, 3.0 million shares of Varian Semiconductor Equipment Associates, 587,560 shares of Intel, 24.4 million shares of Micron Technology, and 899,660 shares of Plexus. Turner held no shares of First Solar.

You can get free copies of other Turner position papers by calling us at 484.329.2329; e-mailing us at marketingteam@turnerinvestments.com; faxing us at 610.578.0824; or visiting the Position Papers page of the Resource Center section of our Web site, www.turnerinvestments.com.

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