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Manufacturers struggle to keep pace with record orders

Supply chain and labour market shortages bring some factories to a halt, with one company boss saying the rush to turn inventories into cash in 2020 was overly pessimistic
Manufacturers struggle to keep pace with record orders
  • Order books hit a 44-year high in November
  • But supply chain issues and labour shortages mean investors won't see this flow through to bottom lines

Record demand is not turning into record profits for the UK's major industrial players because they just can't get the supplies or staff to keep up. 

The Confederation of British Industry’s latest Monthly Industrial Trends Survey found that order books in November grew to their strongest level since records began in 1977. The UK Manufacturing Purchasing Managers’ Index flash data for November also indicated strong growth. The single-figure measurement of the sector’s health grew to 58.2 in November, from 57.8 in October. A score above 50 indicates expansion, while one below 50 denotes contraction.

The index’s growth was driven by the strongest increases in new orders, output and employment since August, data compiler IHS Markit said. Production growth actually slowed when compared with the third quarter, though, as survey respondents said shortages of critical components had led to stoppages.

“Shortages of staff and production stoppages due to a lack of supplies added to frustrations in the manufacturing sector as some machines fell silent,” said Duncan Brock, director at the Chartered Institute of Purchasing and Supply.

More manufacturers are reporting inflationary pressures linked to fuel costs and labour inflation than at any time since January 1998, Brock said.

For many manufacturers, the longer lead times they now need to fulfil orders are a symptom of decisions taken at the start of the pandemic, said Stephen Harrison, chief executive of brick and concrete products maker Forterra (FORT).

“I think businesses, including ours, went into the pandemic thinking, ‘Okay, we’ve no idea how long this will last, we need to protect our cash. So we turned our inventory into cash but then the market came back very fast,” he said.

“With the benefit of hindsight, we’d have liked more inventory and we didn’t need the cash as much as we thought we did.”

This effect can be witnessed in the demand for trucks. Commercial vehicle output increased by 17.2 per cent in October against a weak market in the same month last year as operators delayed renewing fleets due to pandemic concerns and uncertainty over Brexit, according to the Society of Motor Manufacturers and Traders (SMMT).

Production levels for the first nine months of the year are up 15.6 per cent on a Covid-hit 2020, but are still 18 per cent below the pre-pandemic average.

Supply chain stresses continue to hound the broader automotive industry, which has been struggling to source enough semiconductors since the pandemic began. UK car production declined by 41.4 per cent in October and the 64,729 cars produced was the lowest total for the month for 65 years.

SMMT chief executive Mike Hawes described the figure as “extremely worrying”.

“Britain’s automotive sector is resilient but with Covid resurgent across some of our largest markets and global supply chains stretched and even breaking, the immediate challenges in keeping the industry operational are immense.”

Now looming over industry is the Omicron variant of coronavirus, which triggered a sell-off on global markets last week. Manufacturers with exposure to aviation were hit much harder than broader indices. Rolls-Royce (RR), which makes a chunk of its money on how many hours its engines are flown, saw its shares fall 12 per cent as governments such as Israel and Japan closed their borders to foreigners, compared to the FTSE 100 falling 3.6 per cent. Melrose (MRO) shares also fell by 10 per cent but both saw positive movement in the following days as concerns eased slightly. 

HSBC analysts spelled out three scenarios for aviation, with its median view suggesting Omicron could potentially set the sector’s recovery back by six months.

UBS, however, maintained its view of robust growth as the global economy bumps along the road to recovery.

“We advise against hasty shifts in investment strategy,” the Swiss bank said in a note this week, adding that the 26 November negative swing could have been exacerbated by low volumes as US markets remained partially closed due to the Thanksgiving holiday.

In general, the productivity of manufacturers has been good throughout the crisis, Bart van Ark, managing director of the Productivity Institute said.

"Following a rather big hit in early 2020, when the pandemic started, it recovered very strongly during the second half [of] 2020. For 2020 as a whole, manufacturing labour productivity stood at 4.4 per cent above the 2019 level, compared to 0.8 per cent for the whole economy," he said.

However, given that manufacturers are already telling the CBI's survey that stock adequacy has fallen to its lowest level in over 40 years, there is potential for much greater supply chain disruption, according to Capital Economics – particularly if the new variant spreads to China and governments impose more localised lockdowns and temporary port closures.

“A virus-related surge in goods spending, or port closures, would exacerbate existing supply strains and add upward pressure to goods inflation,” Capital Economics’ chief economist Neil Shearing said.

“Likewise, a new, more dangerous, virus wave could cause some workers to temporarily exit the workforce, and deter others from returning, making current labour shortages worse.”

One way the government could step in is tackling high energy costs, the SMMT said.

At 275p per therm, gas prices have risen two and-a-half times since June and are now five times higher than they were 12 months ago, an industry group told parliament last week.

A mix of factors have contributed to higher UK energy prices, including a lack of investment in energy infrastructure, the spiralling cost of carbon credits (which have more than doubled since the start of the year to €74.05, or £62.74, per tonne) and even the higher demand for building materials like concrete from projects like HS2, according to Forterra boss Harrison. 

“Is it a problem? I think a lot of manufacturing businesses could make more and probably sell more at the moment if the supply chains and the labour was available,” he said.

“At the moment, the market is stomaching the inflation. If you look at housebuilders...house prices are going up faster than the cost of inflation, but the risk is if that all stops.”