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Manufacturing profits fall 3% as Canadian companies adjust to stronger dollar

Ottawa, ON -- The Canadian dollar has been trading sideways for several months now. But that still leaves the appre...


Ottawa, ON — The Canadian dollar has been trading sideways for several months now. But that still leaves the appreciation from 62 to 75 cents to be digested — how is that adjustment going?

The data on corporate profits are indicative. Profits rose by 10.4% between 2002Q4 and 2003Q4, hitting a new record, and companies boosted their profit margins from 6.5% to 7.2%. But much of that aggregate increase was in the financial sector, especially deposit-taking institutions, where margins rose from 16.4% to 25.5%. Insurance carriers also saw margins rise from 6.8% to 9.7%.

In contrast, profit margins were basically flat in 2003 for non-financial corporations, rising only slightly from 5.6% to 5.8%. There were some winners: mining saw margins rise from a paltry 2.9% to 7.7%, and oil-gas-coal extraction maintained a strong profit margin of around 17%. More surprisingly, the hospitality sector maintained a margin of around 3.5%, despite the stronger dollar and SARS. Margins also rose in retail and wholesale trade, because of stronger demand.

The biggest hit came in the manufacturing sector, where profits fell 3% and margins dropped from 6.0% to 5.2%. Again, there were some winners — profits rose strongly in the manufacturing of petroleum- and mineral-related products.

But there is also an indication that globalization is insulating some companies from exchange rate fluctuations. Companies that source some inputs from abroad find their costs declining when the Canadian dollar rises in value. Accordingly, the electronics and computer equipment sector — which have a relatively high foreign content — returned to positive profitability in 2003, after making significant losses in 2002. Similarly, the electrical appliance sector also saw profitability improve.

And there were losers, often those with relatively high Canadian content in their products and limited international pricing power. Profit margins have almost halved in clothing, to around 4%, and have declined in primary metals (from 8.3% to 4.6%) and fabricated metal products (7.1% to 5.6%). Smaller drops in margins were recorded in furniture, chemicals, wood and paper.

There has also been a big drop in profitability in the auto sector, less because of the dollar and more because of incentive programs. Overall, these stressed sectors constitute about one-third of total manufacturing profits; and manufacturing contributes 20% of total corporate profits in Canada.

Meanwhile, the dreaded drop in Canada’s exports due to the stronger dollar has not materialized. Measured in Canadian dollars, of course, export revenues as of February were down 2.2% compared to 2003, because most Canadian exports are priced in U.S. dollars. But adjusting the numbers for the arithmetic exchange rate effect shows that export volumes (actual sales) are gathering momentum — they are up 6.9% from a year ago, and have risen 8.3% from their low point last August, which was depressed by Ontario’s power blackout.

The bottom line? The stronger Canadian dollar is causing profit stress in key parts of the manufacturing sector. But the combination of stronger global demand, higher resource prices and continued dollar stability should yield a more favourable and balanced profit picture in 2004.

Stephen S. Poloz is the senior vice-president and chief economist for Export Development Canada, Ottawa, Ont.