Canada: Tariff-Free or Die!

By Will Ashworth

One of the risks of writing about the impact of geopolitics  — or continental politics  — on stocks is that between writing and publishing, things change.

So while I originally wrote this on the eve of the U.S. federal government implementing 25% tariffs on Canadian imports effective yesterday, cooler heads prevailed — at least for now.

Still, the prospect of a trade war, even if only prospective, begs the question of what the impact would be for the companies in the Canadian SMID-Cap 30 and their investors on both sides of the border.

In the coming weeks, I’ll do my best to keep readers abreast of any relevant information that could affect their investments in these 30 companies. 

But with tariffs and trade front and center, I thought that I’d share my views about globalization and how it should work in a perfect world.

The globalization we’ve seen develop over the past 25 years has benefited two groups: Fortune 500 companies and China. Everyone else has gotten by … just. 

Years ago, I came across a Wisconsin-based company, A.O. Smith (AOS), that manufactured tank and tankless water heaters. It sold these in the U.S., Canada, and China and was expanding into India. 

What I loved about the business was that the products sold in each country were primarily manufactured in those countries. So, if it generated $50 million in Canadian revenue, the $50 million was generated from Canadian-produced water heaters. The same went for the U.S. and China. 

That’s how I saw globalization. Manufacturing on the ground virtually eliminates a carbon footprint while substantially cutting shipping costs — a win-win situation. 

“This is the way globalization is supposed to work. Forget shipping product from China to North America and vice versa. Make the product where you’re going to sell it. Your costs will be lower, and you’ll build stronger markets. These guys are doing it the right way. On this alone, I’d own its stock,” I wrote in July 2012 for Investorplace.com. 

How’s A.O. Smith stock done in the 12.5 years since? It has a CAGR of 14.7%, not including dividends, which have grown from 18 cents total in 2012 to $1.30 in 2024, a CAGR of 17.1%. That’s a total return of over 30%. Add in share repurchases, and the return will be even sweeter. 

I’m not trying to pat myself on the back. I’m merely pointing out that AOS stock is tangible proof that some companies have been able to compete in an era of high-margin globalization and do it better while still making reasonable profits. 

Back to the subject at hand.

Donald Trump has one thing right about his tariff push — and it’s not revenue or border security. If he were smart, he’d implement a plan that uses a carrot rather than a stick. 

“My message to every business in the world is very simple: Come make your product in America, and we will give you among the lowest taxes of any nation on Earth,” Trump said in his speech to the World Economic Forum. “But if you don't make your product in America, which is your prerogative, then, very simply, you will have to pay a tariff.”

I 100% agree with that sentiment. Every country should take this approach, including Canada. 

What he gets wrong is he doesn’t have to use tariffs to bring more manufacturing, which he indeed will get because Canadian business leaders have said they will move more manufacturing south of the border to avoid tariffs.

However, suppose the U.S. were to tell foreign companies (and U.S. ones, too) that they would pay a lower tax on U.S. revenue generated from products and services manufactured and produced there. In that case, the revenues generated from new manufacturing would more than make up for the tax cut. 

Rather than give corporations lower tax rates willy-nilly, make them earn those tax cuts. 

Canada should do the same. 

Gildan (GIL) produces its products in the Dominican Republic, Honduras, Bangladesh and Nicaragua. The yarn for t-shirts and underwear is made from cotton and other materials in North Carolina. No products are made in Canada. It does this because of the lower labor costs in these places — except North Carolina, which has a lengthy history and expertise in the apparel industry.

Based in Montreal, it generates just 3% of its revenue from Canada, 90% from the U.S., and 7% outside the U.S. and Canada. Under my idea, it would not receive any tax breaks. 

Now, a company like Premium Brands Holdings (PBH), one of the constituents in the Canadian SMID-Cap 30, would be eligible for significant tax breaks because it has 86 out of its 116 company facilities in Canada, including 37 for manufacturing and the rest for distribution, processing, etc.  

In 2023, Premium Brands had $6.26 billion in revenue ($6.84 billion if you include its 50% ownership in Clearwater Seafoods), 75% of which came from manufacturing and the remaining 25% from distribution.  

Of the $6.26 billion in revenue, 52% was generated in Canada. 

Assuming 75% manufacturing and 25% distribution, the Canadian revenue from manufacturing and distribution would be $3.277 billion, $2.45 billion from manufacturing, and $816.4 million from distribution. 

The tax deduction would be 10% for manufacturing and 5% for distribution. Based on $2.45 billion from manufacturing, the tax deduction would be $245 million. For $816.4 million from distribution, the tax deduction would be $41 million, for a total deduction of $286 million. 

Premium Brands’ 2023 pre-tax income was $133.2 million. The addition of $286 million in tax deductions or credits — I’m not a tax specialist, so I’m guessing the 10% and 5% numbers I used would be much lower--would increase its after-tax net income by reducing taxes paid, providing a real incentive to manufacture/distribute products in Canada to be sold in Canada. 

What Donald Trump is proposing benefits no one. 

Sure, he would argue that he will lower the U.S. federal corporate tax rate below 21%, the existing rate, to 15%, delivering tax cuts to offset the tremendous revenue generated from tariffs.

Will it help increase investments in manufacturing by companies doing business in America? It didn’t when the rate dropped from 35% in 2017 under Trump’s last administration.

If Americans want more manufacturing jobs, President Trump has a strange way of fulfilling their wishes. This is bound to end badly for America and, possibly, Canada.

Disclaimer: The author did not hold a position in any of the securities mentioned above. The information provided in this article is for educational and informational purposes only and should not be construed as investment advice. Always conduct your own research or consult with a licensed financial professional before making any investment decisions. Past performance is not indicative of future results.

Will Ashworth is currently ranked 111 out of 30,613 financial bloggers analyzed by TipRanks, with a 19% return on his buy and sell ratings. He is one of the founding contributors to this newsletter.

Will has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.