Industrial Machinery Stock Outlook - May 2016

First quarter 2016 results seem to be hindered by the same headwinds that had adversely influenced the previous four-quarters. While economic uncertainties prevailed in some major developing and developed nations, soft commodity prices and adverse impacts of unfavorable foreign currency moves kept the growth momentum restricted for a few industries in the first quarter.

As a result of the weakening health of the global economy, the International Monetary Fund (“IMF”) lowered its world economic outlook to 3.2% for 2016 and 3.5% for 2017. Economic growth forecasts for advanced and emerging economies have been lowered by 20 basis points (bps) for 2016 and 10 bps for 2017.

The level of industrial activity is measured in terms of industrial production, which comprises the output of manufacturing, mining and utilities sectors. A brief discussion on the machinery industry in different nations is given below.

The United States

We believe industrial products stocks in the U.S. are negatively influenced by the prevailing macro headwinds. Industrial production in the country fell roughly 2.2% in first-quarter 2016 as compared with a 3.4% decline in the previous quarter. The job market showed relative weakness in the quarter, evident from an average jobs addition of 209,000 per month, down compared with 282,000 in the preceding quarter.

To add to the woes, unfavorable foreign currency movements and economic uncertainties worldwide led to weak export demand for U.S.-manufactured machinery. According to the U.S. Census Bureau, export demands for U.S. machinery declined 1.6% year over year for the first two months of 2016. A 12.1% decline was recorded for shipments of farm machinery; while construction and mining machinery saw a 24.4% and 44.9% fall. The exception was a 22.7% increase in shipments of industrial machinery.

New machinery orders were down 0.9%, while order backlog decreased 8.3%.

The International Monetary Fund (“IMF”) has reduced its growth projections for the U.S. economy by 20 basis points (bps) to 2.4% for 2016 and by 10 bps to 2.5% for 2017.

Japan

The country’s economy is struggling with its internal issues as well as facing the adversities of weak economic conditions externally. Low investment levels, unfavorable exchange rates, aging population and a huge public debt are some headwinds affecting the country’s progress.

According to the report from Japan’s Cabinet Office, core machinery orders fell nearly 9.2% in February as against the previous month’s growth of 15%. The fall in core machinery orders has triggered concerns over the future of capital investments by companies.

Orders from manufacturing clients declined 30.6% while the same from the government clients grew 25.9%. The agency predicts core machinery orders to grow 6.4% in the first-quarter 2016, while total machinery orders are expected to increase 2.2%.

The IMF predicts the economy to grow by 0.5% in 2016, inching down by 10 bps in 2017. These projections reflect a 50 bps and 40 bps downward revisions from previous forecasts for 2016 and 2017, respectively.

Emerging Nations

China: In first-quarter 2016, China’s GDP grew 1.1% sequentially, below the 1.5% growth recorded for fourth-quarter 2015, while on a year-over-year basis increased 6.7% versus 6.8% in the year-ago period. Despite the fall, the country’s economy seems to be stabilizing.

In March, the country’s industrial production increased 6.8% year over year, an improvement from the 5.4% average growth for January and February. The increase was driven by an improvement in mining, manufacturing and utilities sectors. Also, the country’s exports increased 11.5%. Imports dropped 7.6%.

The IMF projects the Chinese economy to grow by 6.5% in 2016 and 6.2% in 2017, reflecting a 20 bps increase over the previous projections.

India: The country’s industrial production in Feb 2016 increased 2% year over year. Expectations of strong demand, improved policies and better monsoon conditions are factors that will influence the country’s growth going forward. The new government is making concerted efforts to turn the country into a prime manufacturing hub for all nations across the world.

Apart from boosting the foreign capital inflow in the country, these strategies will serve to improve the domestic job markets as well as demand for industrial products. According to the IMF, the country is projected to grow 7.5% in both 2016 and 2017.

Brazil: For 2016, the country projects a gloomy outlook as a result of low private investments and inadequate infrastructure. The country’s unemployment rate increased to 10.9% in first-quarter 2016, up from 9% recorded in the quarter-ending Dec 2015. Also available data reveals that the country’s industrial production fell 9.8% year over year in February.

The IMF predicts the country’s output to decline by 3.8% in 2016, remaining flat in 2017. The recovery is dependent on foreign direct investments and expansion of industries like tourism, steel and electricity.

Eurozone

Industrial production in the Eurozone fell 0.8% month over month in Feb 2016 while inched up 80 bps year over year. Though the unemployment rate was high at 10.2% in Mar 2016, it represented a 20 bps improvement over the rate of 10.4% in February.

The IMF revised down its growth projections for the Euro Area by 20 bps to 1.5% for 2016 and by 10 bps to 1.6% for 2017.

Zacks Industry Rank

According to the Zacks Industry classification, Machinery is broadly grouped under Industrial Products, one of the 16 broad Zacks sectors. The Zacks sectors comprise 265 industries that are ranked on the basis of the earnings outlook of constituent companies in each industry. To learn more visit: About Zacks Industry Rank

As a rule, the top 50% industries of all Zacks industries outperform the bottom half by a wide margin. Going by this rule, industries with Zacks Industry Rank of 132 and lower would fall in the top half, while those with Zacks Industry Rank of 133 and higher would be in the bottom half.

The machinery industry is sub-divided into 9 industries at the expanded level: machine tools and related products, construction and mining, electrical utilities, electrical, farm, general industries, material handling, print trading and thermal processing.

Earnings Trend of the Sector

As of May 9th, we have Q1 results from 95.2% of the companies in the S&P 500’s Industrial Products sector. Total earnings for these Industrial Products companies are down -21.3% from the same period last year on -8.6% lower revenues, with 70% of the companies beating EPS estimates and equal proportion coming ahead of revenue expectations. For the quarter as a whole, total earnings for the sector are expected to be down -22.8% on -9.4% revenues.

The trend of earnings declines is expected to continue for the sector, with Industrial Products earnings in the June quarter expected to be down -7.2% on -5.4% lower revenues.

Key Players in the Machinery Industry

Stocks with high investment rankings might interest investors who seek exposure in the machinery industry. Below we have briefly discussed some stocks that hold strong long-term potential and a high investment ranking of Zacks Rank #2 (Buy):

In the S&P 500 group, machinery company Xylem Inc (NYSE:XYL). (XYL), with a market capitalization of $7.5 billion, has strong earnings growth potential, roughly 10.6% over the next five years. Another machinery company, Pentair plc (PNR), with $10.5 billion market capitalization, offers 9.7% earnings growth. Industrial robotic company Rockwell Automation Inc (NYSE:ROK). (ROK), with $14.9 billion market capitalization, offers 7.6% long-term earnings growth.

Other billion-dollar stocks in the S&P 500 group with Zacks Rank #2 and long-term earnings growth rate in excess of 7% include Parker-Hannifin Corporation (NYSE:PH) (PH), Ingersoll-Rand Plc (IR), W.W. Grainger, Inc. (GWW), Eaton Corporation plc (ETN), Emerson Electric Co. (EMR) and Avery Dennison Corporation (NYSE:AVY) (AVY).

Non-S&P 500 billion-dollar stocks in the machinery industry, with strong long-term earnings potential, are AO Smith Corp. (AOS), Rexnord Corporation (RXN) and Atlas Copco AB (ATLKY).

Going Forward

We believe global uncertainties will likely restrict the growth of machine and tool manufacturers, going forward. The much-needed improvement in the economy as well as industrial products sector can only be achieved on the back of effective governmental policies, huge infrastructural investments, creation of more jobs and emphasis on trade relations.

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