"Made in China" − The epithet immediately brings to mind cheap labor and the outsourcing boom that transformed China into the global hub for manufacturing jobs, powering it to become the world’s second-largest economy. However, China’s advantage seems to be waning as climbing wages and rising energy costs increasingly exert pressure on the country’s forte − its low-cost manufacturing prowess.
Factors Curbing China
Wages in the world's most populous nation are soaring, reducing its low-cost advantage. In the last decade, Chinese wages have grown nearly five-fold, driven by an expanding middle class segment and higher minimum wage criteria.
Elevated energy costs are also stifling the country's manufacturing competency. In the last decade, the cost of industrial electricity rose by about 66% in China while the cost of natural gas soared by about 138%, according to Boston Consulting research. This is in contrast to a 25% decrease in gas prices in the U.S., induced by the boom in shale gas production.
Steady currency appreciation, steeper shipping costs and costlier maintenance of longer supply chains added further pressure to the manufacturing costs in China. The country has been witnessing slow productivity growth and weaker logistics as well.
The Reshoring Phenomenon
With increases in Chinese wages and declines in U.S. energy costs, the disparity between manufacturing costs in China and the U.S. has narrowed a great deal. For every dollar in cost of manufacturing in the U.S., it now costs 96 cents to manufacture in China – even before transportation and inventory costs are factored in. For most companies, the scant cost benefits are outweighed when product quality, intellectual property rights, and long-distance supply chain issues are added to the equation.
In fact, per a recent study by the consulting firm AlixPartners, the cost of outsourcing manufacturing to China will be equivalent to the cost of manufacturing in the U.S. by as early as 2015. Consequently, more and more companies are relocating their plants out of China to other cheaper locations, including the domestic frontiers.
Surprisingly, a growing number of American companies are now reversing the offshoring trend, bringing manufacturing back to the country in a trend coined by industry experts as "insourcing" or "reshoring." Adapting to the changing landscape, these companies look to benefit from their home country’s reasonable wage growth, sustained productivity gains, stable exchange rates, and the remarkable energy advantage.
Shifting to Greener Pastures
The reshoring trend is most likely to be adapted by industries that have relatively low labor-cost components and high transportation-related costs. Sectors that seem vulnerable to the trend include computers and electronics, appliances and electrical equipment, furniture, and transportation goods.
Included in the companies reversing the offshoring trend is diversified conglomerate General Electric Co. (GE - Analyst Report), which moved production of its energy-efficient water heater from Chinese contractors to its own factory in Louisville, KY. Even auto majors Ford Motor Co. (F - Analyst Report) and Toyota Motor Corp. (TM - Analyst Report) have brought some of their products back to the U.S.
Mining and construction equipment giant Caterpillar Inc. (CAT - Analyst Report) decided to shift some manufacturing operations to southern U.S. and also announced nine new plants or expansion projects in the country over the past year. Appliance maker Whirlpool Corp. (WHR - Analyst Report) brought back production of its KitchenAid hand mixers, previously made by a contractor in China.
Two Stocks to Dump
There is no doubt that shifting an installed manufacturing base is fraught with challenges. Apart from the availability of skilled labor, China still retains an upper hand in manufacturing infrastructure. Additionally, a number of U.S. companies are still battling declining revenues and rising costs. For these, the benefits of shifting manufacturing operations cannot seem to justify the associated costs. At the same time, continuing with Chinese manufacturing units will not permit them to reduce operating expenses.
Here we discuss two such companies that seem to face a catch-22 situation in terms of dealing with this issue. Both these stocks have been witnessing downward estimate revisions as well.
ANN INC. (ANN - Snapshot Report)
This specialty retailer sources a significant part of its goods from China, and rising costs have had a negative impact on its profitability. The company missed revenue estimates in its second-quarter results, citing weaker traffic levels and an increasingly competitive environment.
Due to the rising labor, electricity and shipping costs, the company’s per unit production cost in China is much higher than its other sourcing locations such as Indonesia, Vietnam and Cambodia. However, China’s established supply chain systems and developed infrastructure somewhat restrict the company’s ability to relocate to more cost-efficient destinations.
The company has witnessed sharp negative estimate revisions over the past month. The Zacks Consensus Estimate for the upcoming quarter declined 24% to 79 cents per share. For 2015, the Zacks Consensus Estimate reduced 13.8% to $2.06 per share.
Moreover, ANN presently sports a Zacks Rank #5 (Strong Sell).
Wal-Mart Stores Inc. (WMT - Analyst Report)
This supermarket giant has been facing glitches in China as it grapples with intense competitive pressure from local rival Sun-Art Retail Group, which has adapted itself relatively better according to local preferences. Slow economic growth has also hindered Wal-Mart’s profitability in the country.
Rising labor and transportation costs have amplified the pressure on its margins. Wal-Mart’s business model greatly depends on low product-pricing. Of late, the retailer has been striving to find manufacturers in the U.S. in an attempt to improve its cost efficiency.
Nevertheless, the company has witnessed sharp negative estimate revisions over the past month. For the upcoming quarter, the Zacks Consensus Estimate declined 5.0% to $1.13 per share. For 2015, the Zacks Consensus Estimate reduced 2.7% to $5.04 per share.
Though Wal-Mart currently carries a Zacks Rank #3 (Hold), we don’t expect the stock to perform better than its peers in the near term.
China's age-old tactic of attracting wage-sensitive manufacturers seems to have reached a saturation point. The country's rising middle class and a multitude of problems have culminated into a shift in its economic reality.
To survive this changing landscape, China needs to catch up with the U.S., Germany and Japan in terms of quality and product design. Simultaneously, it needs to sustain its cost efficiency to maintain its edge over countries like India or Indonesia.
Companies will continue to seek low-cost manufacturing destinations as they adapt to the changing landscape. Whether that is in even lower-wage areas such as Vietnam or India or in countries that offer superior productivity and less logistical costs, such as the U.S. and Mexico, remains to be seen.
In simple terms, the halcyon days of 'Made in China' have come and gone.