What it means
Investopedia describes a smokestack industry as heavy manufacturing that produces large items or inputs into other industries. The term points to the banks of chimneys that released smoke into the air, and such industries have long been seen as central to industrialisation and to development in emerging economies.
The label also carries a view of the economy. Investors often call these sectors the old economy, because sales rise and fall with the business cycle.
They need large amounts of capital, so plants and equipment are costly, and bigger output can lower the cost per unit. Pollution and environmental impact are a standing concern.
Rules on emissions can add costs and change which plants stay open, so a company in this group may face both cycle risk and regulatory risk. The US Bureau of Labour Statistics gives a sense of how the heavy manufacturing story has changed.
Total US manufacturing employment reached an all-time peak of 19.6 million in June 1979, and by June 2019 it was 12.8 million, which BLS reports as down 6.7 million, or 35%. BLS also notes that manufacturing's share of total nonfarm employment peaked at 32% in May 1953, leaving out the World War II period.
Employment fell in each of five recessions since 1979 and did not fully recover to the level before them, and these figures cover all manufacturing, not only heavy industry, so they are a broad guide. The term is a label, not a legal category, so check how a source defines the group, since different writers include different sectors and some modern plants are clean and highly automated.
For an investor, the useful questions are practical: how much of the cost base is fixed, how much debt sits on the balance sheet, and how exposed are orders to a single customer industry? The answers matter more than the label.
In practice
Real-world examples.
Example
A fictional steel mill costs $900 million to build and sells most of its output to car makers. When car sales fall 20% in a recession, its orders fall too. The fixed cost of the plant stays the same, so profit drops faster than sales.
Example
A fictional shipyard builds 4 large vessels a year at a cost of $120 million each. Total yearly cost is $480 million, plus $60 million of fixed overhead, or $540 million. If it builds 6 vessels, the overhead per vessel falls from $15 million to $10 million, which shows why bigger output can lower the cost per unit.
Example
A fictional region has 100,000 factory jobs in 1979 and 65,000 in 2019. That is a fall of 35,000 jobs, or 35%, similar in size to the US manufacturing drop BLS reports. The figures are illustrative and not real data.
Formula
Calculation
Percentage change = (New level - Old level) / Old level x 100. With (12.8 - 19.6) / 19.6 x 100 = -34.7%, which BLS rounds to 35%.
Overhead per unit = Fixed overhead / Units. With $60 million / 6 = $10 million.
Degree of operating leverage = Percent change in profit / Percent change in sales. With a 50% profit fall on a 20% sales fall, the ratio is 50 / 20 = 2.5.Case study
Seen in the real world.
This case study is fictional and illustrative. Marta, 45, in Pittsburgh, follows a regional steel firm and compares it with a software company. Steel revenue swings from $2.0 billion to $1.5 billion in a recession. Her notes list the plant costs, the debt and the emission rules the firm must meet.
She sees that most costs are fixed, so a 25% revenue fall hurts profit far more than 25%. Her spreadsheet makes the point. At $2.0 billion of revenue, variable costs of $0.8 billion and fixed costs of $0.8 billion leave a profit of $0.4 billion. At $1.5 billion, variable costs fall to $0.6 billion but fixed costs stay at $0.8 billion, so profit is $0.1 billion, down 75% on a 25% revenue fall.
She compares the firm with the software company, which has lower fixed costs. She decides the steel firm needs a lower price to justify its cycle risk. She sets a rule to review the firm each quarter. She checks the order book and the debt before she changes her view.
Watch out
Common mistakes.
- Assuming every manufacturer is a smokestack industry, when the term usually means heavy and older sectors.
- Treating total manufacturing job data as proof about one company or sector.
- Ignoring fixed costs and debt, which make profits swing more than sales in a downturn.
Questions
People also ask.
What is a smokestack industry?
It is a traditional heavy manufacturing sector, such as steel, shipbuilding, chemicals or heavy machinery. The name refers to factory chimneys.
Why are these industries called old economy?
Investors see them as mature and cyclical, with big capital needs and environmental concerns. Newer sectors often have lower fixed costs.
Did US manufacturing employment fall?
Yes. BLS reports a peak of 19.6 million in June 1979 and 12.8 million in June 2019, a drop of 35 percent.
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