Near-Term Outlook Bleak For Manufacturing Tools Industry

The Zacks Manufacturing-Tools & Related Products industry comprises companies that develop and distribute hand and mechanics tools, hydraulic tools, engineered fastening systems and motion control systems. Arc welding products, oxy-fuel cutting equipment, plasma cutters, storage system and other related products are also produced by some tool makers.

The highly advanced tools are used in industrial, commercial, oil & gas, mining, automotive, and other industries. Providers of electronic security solutions cater to demand in the commercial, retailers, government, financial and healthcare markets. Two important players in the industry are Lincoln Electric Holdings, Inc. (LECO) and Sandvik AB (SDVKY).

Here are the industry’s three major themes:

• The industry is suffering from adverse impacts of global uncertainties (including those related to Brexit), strained trade relations and unfavorable movements in foreign currencies, among others. It is worth noting here that the International Monetary Fund has lowered its growth projection for the global economy by 20 basis points (bps) for 2019 and by 10 bps for 2020.
  
• The companies are facing headwinds from disturbed trade relations of the United States with other nations, especially China. Notably, imposition of tariffs by the United States on the import of steel, aluminum and an array of other products triggered the tensions. Tariffs have been hurting corporate margins (as a result of escalation in raw material costs) over the past few quarters. Commodity inflation, high labor costs and freight charges have also added to the woes. The industry’s cost of sales increased 10.1% year over year in 2018 and 3.7% in the first nine months of 2019. Meanwhile, the government’s efforts to lower tariff-related woes by reaching a phase-one trade deal with China might be a relief.
  
• Focus on infrastructural development in the country, increasing use of sophisticated technologies in manufacturing process and demand for remodeling activities are aiding the industry. Also, the growing adoption of e-retailing has created business opportunities for tool makers. Added to these, the corporate tax overhaul (introduced in December 2017) will continue to aid industry players. Further, month-over-month gain in industrial production in November 2019 is a healthy sign for manufacturing companies. The industry’s revenues increased 7.6% year over year in 2018 and 1.4% in the first nine months of 2019.

Zacks Industry Rank Indicates Weak Prospects

The Manufacturing-Tools & Related Products industry is a five-stock group within the broader Zacks Industrial Products sector. The industry currently carries a Zacks Industry Rank #221, which places it in the bottom 13% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak prospects in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of dull earnings prospects for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates have declined 10.8%.

Before we discuss a few stocks in the industry, let’s take a look at the industry’s shareholder returns and current valuation.

Industry Outperforms S&P 500 & Sector

The Zacks Manufacturing-Tools & Related Products industry has outperformed the S&P 500 and the sector over the past year.

While the industry players have collectively gained 32.6%, the S&P 500 and the sector have rallied 28% and 23.9% respectively.

One-Year Price Performance



Manufacturing-Tools & Related Products Industry’s Valuation

EV/EBITDA ratio is one of the commonly used methods for valuing manufacturing tools and related products stocks.

The industry’s forward 12-month EV/EBITDA ratio is 9.48. This clearly shows that the industry is trading below the S&P 500’s forward 12-month EV/EBITDA ratio of 12.66 and the sector’s 17.8.

Over the past five years, the industry has traded at the highest level of 11.02X forward 12-month EV/EBITDA and lowest level of 7.15X. The median level, over the same period, was 8.86X.

Industry’s EV/EBITDA Ratio (Forward 12-Month) Versus S&P 500



Industry’s EV/EBITDA Ratio (Forward 12-Month) Versus Sector



Bottom Line

Prevalent headwinds — including tariffs, commodity inflation, forex woes, and high labor and freight charges — pose serious threats to corporate margins and profitability. Considering the magnitude of the adverse impacts, we believe that the industry might not be able to tide over it in the near term.

Nonetheless, we present two stocks that investors might prefer to retain in their portfolio based on their impressive results in the past quarters.

Actuant Corporation (EPAC): The stock of this Menomonee Falls, WI-based company has gained 24.8% in the past year. The stock currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The company delivered positive earnings surprise in the last four quarters, with the average being 18.57%. In the last reported quarter, it delivered positive earnings surprise of 33.33%.

Price and Earnings Surprise: EPAC



Stanley Black & Decker (NYSE:SWK), Inc. (SWK): This stock of this New Britain, CT-based company has increased 38.3% in the past year. The stock currently carries a Zacks Rank #3.

The company’s earnings surpassed estimates by 5.45% in the last reported quarter. Its average positive earnings surprise in the last four quarters is 9.71%.

Price and Earnings Surprise: SWK



Meanwhile, there is one stock in the industry that can be avoided by investors.

Kennametal Inc. (KMT): The stock of this Pennsylvania-based tool maker has increased 11.3% in the past year. The stock currently carries a Zacks Rank #5 (Strong Sell).

The company delivered weaker-than-expected results in two of the last four quarters, met estimates in one and surpassed estimates in another. Average earnings surprise for the last four quarters was negative 0.80%.

Price and Earnings Surprise: KMT



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