Woe, Canada: USA's economic chill spreads north

It didn't take long for fallout from the United States' deteriorating economy to reach this frozen industrial heartland.

At Maxtech Manufacturing, which produces precision parts for vehicles made by Detroit's Big Three automakers, sales fell 10% in 2007 and appear headed for at least that big a drop this year. Profits, meanwhile, have melted like ice on a summer's day.

"Our volumes are dropping dramatically. … We're fortunate we're still in business," says CEO K.C. Vasudeva.

Maxtech's woes illustrate how the financial turmoil that began in an obscure corner of the U.S. mortgage market is spreading real economic pain beyond U.S. borders. Among the first to feel the effects is the USA's neighbor and chief trading partner, Canada.

More than three-quarters of Canada's exports — including oil, minerals, lumber and passenger vehicles — are sold to Americans. The U.S. housing collapse already has slashed sales of Canadian lumber. Now, as a historic decline in home values causes American consumers to retrench, U.S. auto sales this year are headed to a 10-year low, according to TD Bank Financial Group in Toronto.

"The U.S. is buying less of our stuff. This is going to be a major problem for the Canadian economy," says Michael Gregory, senior economist at BMO Capital Markets in Toronto.

GM gm, Ford f and Chrysler have announced modest production slowdowns in their Canadian factories, which build cars and trucks for the North American market. But Toyota tm and Honda hmc are expected to increase output in Canada, offsetting most of that decline. And the major automakers, and their largest subcontractors, are big enough to weather any downturn.

The big hit from the U.S. slump is expected to fall on smaller Canadian auto parts makers, many of whom are almost wholly dependent upon the American market. Earlier this month, tiny Cambridge Stampings, a nearby metalworking firm, announced it would shut down in April, idling about 70 workers. That was at least the fourth local supplier in this area, about an hour's drive west of Toronto, to close or announce job cuts in recent weeks. It won't be the last.

"The U.S. slowdown is certainly going to have a major impact on the Canadian parts sector. … There's a ton of parts companies in Ontario that are 100% dependent on GM, Ford and Chrysler," says Anthony Faria, director of the office of automotive research at the University of Windsor.

More Canadian-made parts are used in cars produced in the USA than in vehicles assembled in Canada.

Last year, Canada shipped $18.1 billion worth of parts to auto plants in the USA, 10.1% fewer than the previous year, according to the U.S. Commerce Department. Though monthly figures are notoriously volatile, December numbers — down 17.5% from the same month in 2006 — suggested the downturn is accelerating.

"We're getting hammered in the auto parts industry," says Buzz Hargrove, 63, president of the Canadian Auto Workers union.

Apart from the reeling factory sector, however, Canada's economy remains healthy. An energy boom centered on the Alberta oil sands projects, designed to harvest petroleum from sludgelike underground deposits, is fueling robust growth in the West.

Last year, Canada's economy grew faster than the USA's for the first time in five years. The unemployment rate in January hit a 33-year low of 5.8%, and University of Toronto forecasters expect the economy to continue growing this year.

At the Eaton Center shopping mall in downtown Toronto, there are thick crowds even on a weekday afternoon. Jean Norman, 55, a recent retiree from an executive post at the local public transit company, says she's not worried about a potential U.S. recession spilling across the border.

"I just think we're a couple of steps ahead and have distanced ourselves enough so we can probably get beyond it," she says.

Uncertainty ahead

But the first glimmers of consumer unease are appearing. In the past three months, the percentage of Canadians expecting the economy to improve this year plummeted to 25% from 49%, according to Nanos Research. Those worried about a downturn rose to 33% from just 20% in November.

Pharmacist Nadeen Habib, 32, says she fears that a U.S. decline could depress the entire global economy, not just Canada. "I feel it's not stable at all," she says. "At any moment, something could cause a crash."

For embattled Canadian manufacturers, the deepening U.S. economic downturn couldn't have come at a worse time. Auto parts suppliers have been deeply wounded by the lofty Canadian dollar, which makes their products more expensive for Americans.

The Canadian currency, known as "the loonie," cost 62 cents in 2002. By October 2007, for the first time, it cost more than $1.00, close to where it trades today.

Parts makers also see potential trouble in Detroit's path-breaking 2007 labor agreement with the United Auto Workers, which opened the door to a two-tier wage system.

Beginning in 2010, automakers can hire new workers for roughly half the $26 hourly wage of today's assembly-line operators, making U.S. parts makers much tougher competition for their Canadian counterparts. "I think it's a game-changing event," says Gerry Fedchun, president of the Automotive Parts Manufacturers Association.

In a bid to repair their competitiveness, Canadian manufacturers are streamlining operations, rethinking production systems and shedding workers.

The past year, Canada lost more than 113,000 manufacturing jobs; auto parts companies cut about 13,000 positions over that time, says analyst Carlos Gomes of Scotiabank. This year, an additional 7,000 parts jobs could evaporate.

At Maxtech, the 300-person workforce has shrunk from a 2001 peak of around 500 employees. Vasudeva has slashed overhead by consolidating two plants into a single facility. To conserve cash, he's delaying investments, including the purchase of a $400,000 robotic inspection unit for his assembly line.

The belt-tightening represents a painful retrenchment for Vasudeva, 62. The son of an accountant and a homemaker, he grew up in the northern Indian city of Ludhiana, a center of textiles and light manufacturing. One of six children, he emigrated to Canada in 1971 looking for the opportunities not easily found amid that era's stagnant socialism in India.

Soon after, he launched his first business in Canada with $2,000, a single machine and a garage for a factory. By 2001, Maxtech reached its peak annual sales of around $100 million, roughly twice the current level.

Among its signature products are small stainless-steel fittings that monitor the amount of unburned gas in a vehicle's exhaust system. Vasudeva says he's been able to out-compete rival firms thanks to innovation that's driven the unit price of such parts from 82 cents in 1990 to about 38 cents today — despite rising raw material costs. But he frets that such ingenuity won't be enough to offset the headwinds buffeting manufacturing. "I think Canadian industry is going to suffer dramatically," he says.

Companies such as Maxtech are especially vulnerable because of their near-total reliance on orders from GM, Ford and Chrysler.

For years, Vasudeva's customers have been losing market share to more nimble Asian rivals. Like many Canadian parts makers, Maxtech has had limited success in winning orders from Japanese or South Korean carmakers, who have a reputation for bringing their home-country suppliers with them when they establish factories abroad.

New markets help

One company that has diversified beyond North America is Samco Machinery of Scarborough, an industrial neighborhood on the outskirts of Toronto. A maker of factory equipment for automotive and construction companies, Samco was forced to seek out new markets outside the USA when the steep downturn in construction eviscerated its sales.

The company's machines transform coiled steel into metal studs used in construction, as well as components for large rooftop air conditioners. But last year, as demand for new apartment and commercial buildings nosedived, about $10 million in Samco's U.S. orders vanished.

In response, the company went after new customers in India. The fast-growing Asian nation was a natural target: Roughly one-quarter of Samco's 130 employees were of Indian descent, including Raj Kohli, the company's vice president for engineering.

Despite the steep decline in its U.S. business, Samco has been able to double total sales to $28 million in the past five years. Last year, the company scored a major order from Tata Motors, the Indian carmaker that this fall plans to introduce the world's cheapest car.

Under a $3 million contract, Samco is producing machines that will turn flat ribbons of steel into 9-foot-long structural supports for the $2,500 car's chassis. Samco is scheduled to ship the first of the 20-ton machines to India next month.

The company's success offers a lesson in how manufacturers in high-wage countries such as Canada or the United States can succeed.

Samco nabbed the Tata order because its cutting-edge metal-bending technology isn't available in India. And the production approach it designed, enabling a single machine to produce six distinct parts, was less expensive overall than traditional methods, Kohli said. "This is quite new and different. It offers substantial savings," he said.

Struggling auto parts makers won't be able to duplicate Samco's achievement overnight. And some say the industry's predicament will get worse before it gets better.

The impact of the strong Canadian dollar will only fully be felt this year as contracts that were signed several years ago come up for renewal, says auto parts industry representative Fedchun.

New U.S. security requirements have the potential to slow border traffic, discouraging automakers from placing new orders with Canadian firms. And the U.S. downturn could prove deeper and longer-lasting than expected.

"It's certainly going to get a little worse," says Fedchun. "It's pretty painful."