Manufacturers prep for new tariff regime

President-elect Donald Trump’s pledges to impose broader tariffs on most goods from US trading partners and a heavy levy on Chinese goods have, as usual, triggered a maelstrom of skepticism, anxiety and excitement.

Now, advisers and investors with exposure to manufacturing and associated sectors tell me companies are bracing for the possibility of higher import costs and other protectionist measures, with some already taking decisive action.

Others, such as domestic manufacturers, are banking on the potential upsides of business-friendly policy changes.

Pessimists prepare

Jumping into action, some food and beverage producers and sellers of apparel, houseware and electronic goods are making defensive moves by stockpiling raw materials and parts from China to cushion the potential increase in import costs. In one example, a nutrition bar-maker was ordering massive quantities of supplies from China, according to Jeremy Tancredi, a partner leading the supply chain team at digital services consultant West Monroe.

Elsewhere, industrial manufacturers are using hedging contracts to lock up prices for commodities, including steel and rare earth minerals, which are largely imported from China.

The advisers have also seen vendors hold off on providing quotes to their customers beyond Trump’s inauguration day, in fear that the president-elect will use executive orders to push through higher tariffs the moment he assumes office.

Businesses are also preparing to slim down operations reduce costs, and sell non-core divisions and excess assets—mostly plants, land or warehouses—to bolster cash reserves and improve margins.

In another calculus, companies are mapping out their supply chains and weighing the costs and benefits of keeping their production in China versus reshoring to other locations.

An executive from a middle-market PE firm investing in specialty manufacturing who wished to remain unnamed told me the firm is evaluating various scenarios, including exploring relocation options, for an aftermarket auto parts distributor with operations in Vietnam. The firm, though, is holding off on any action until the new administration unveils concrete tariff policies.

Overall, these companies are aiming to strengthen their positions against potential risks posed by tariffs and pressures such as inflation and interest rates, said Michelle Ritchie, PwC global leader of industrial manufacturing and automotive deals.

Private equity impact

This whirlwind of preemptive action has occurred in the few weeks since Trump won the White House.

“It’s a conversation that is happening in all the C-suites, and it’s happening especially at the private equity firms, who are looking at a hold period,” Ritchie said. “It’s much like the inflation and interest rates we’ve been talking about over the last six to 12 months. This adds another layer to it.”

Certain sectors are expected to be affected more by tariffs than others. These include automotive, consumer electronics, and apparel manufacturers and retailers, which rely more on Chinese imports, advisers said.

Meanwhile, smaller companies may be more susceptible to the financial hardships of elevated costs and supply chain disruptions than their larger counterparts.

Inflation and high interest rates have already placed pressure on the financial health of some middle-market companies. Tariffs will deal another blow to these companies, leading to more financially strained companies and restructuring opportunities for PE firms, said James Gellert, the executive chairman at RapidRatings, which provides financial health ratings.

Optimists anticipate benefits

Alongside anxiety about change comes excitement.

Trump’s policies to reduce the regulatory burden on businesses and boost traditional energy production will be a boon for American manufacturers, said KPS Capital Partners co-founder and managing partner Michael Psaros. The New York-based PE firm manages $22 billion in assets and invests in manufacturing and industrial companies that operate globally.

Psaros anticipates that the incoming administration may renew the expiring Republican tax cuts and impose business-favorable tax code changes.

This includes maintaining or lowering corporate taxes and reinstating a tax code that allows companies to immediately deduct 100% of the cost of qualifying assets—equipment, for example—rather than depreciating them over time.

KPS invests billions of dollars each year in modernizing manufacturing facilities across its portfolio: One of its companies is in the middle of a $700-million plant modernization. Therefore, maintaining the current tax plan will be critical for the firm, Psaros said.

Under the Tax Cuts and Jobs Act of 2017, the rate for bonus depreciation phased down to 40% this year and will be reduced to 20% in 2025.

As to the sweeping tariff plans that could spike input costs and accelerate inflation, Psaros doubts the president-elect will be able to deliver on his aims to implement across-the-board tariff policies.

“I’m just curious how much of the current posturing by the administration is a negotiating strategy,” he said.

Some other industry professionals share his view.

“US manufacturing is going to be a focal point of that administration for the next four years, and that’s bringing a lot of excitement,” said Andrew Wronski, Foley & Lardner partner and the chair of the firm’s manufacturing practice.

“Tariffs are creating some uncertainty, but overall, I think excitement is the word to use about the incoming administration.”