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Industry Suppliers-Box Makers May Show Slow U.S. Growth

Investors may see more signs of slowing U.S. manufacturing growth when makers of corrugated boxes and distributors of supplies report quarterly earnings this month.

W.W. Grainger Inc. (GWW) and Packaging Corp. of America are among companies that offer “good insight into industrial America,” said Tim Ghriskey, who oversees about $2 billion as chief investment officer of Solaris Group, based in Bedford Hills, New York. Data from these businesses can be particularly useful in verifying or contradicting the pace of activity measured by the government and third-party groups, he said.

“These types of companies are a great way of evaluating real demand in manufacturing,” Ghriskey said.

The consensus reflects slowing expansion, with no signs of recession, as concerns intensify that the world’s largest economy may be faltering.

The business environment “continues to move sideways” for Memphis, Tennessee-based International Paper Co. (IP), the world’s largest pulp and paper maker, Tom Ryan, a spokesman for the company, said in a June 29 interview. Even so, an improving housing market has made demand for durables, such as appliances, a “bright spot,” he said.

Shipments for the box-making industry fell 0.6 percent on an average-week basis in May from a year earlier, the second consecutive month of year-over-year declines, based on data from the Fibre Box Association in Elk Grove Village, Illinois. June numbers are scheduled to be released July 17, the day after Packaging Corp. plans to announce earnings, followed by RockTenn Co. (RKT) on July 24 and International Paper July 26.

Shipping Barometers

Packaging Corp., based in Lake Forest, Illinois, and RockTenn, in Norcross, Georgia, are barometers for shipping activity, Ghriskey said. Demand for the containers they and their competitors make -- which hold items including appliances and food -- typically rises at about half the pace of gross domestic product, according to Steve Chercover, senior vice president and senior research analyst in Lake Oswego, Oregon, at D.A. Davidson & Co.

Box shipments have increased 1 percent this year through May on an actual, rather than average-week, basis; the U.S. expanded 2 percent in the first quarter from a year earlier.

“These data tie together to confirm the economy is growing slowly,” Chercover said.

Falling Index

The Institute for Supply Management’s manufacturing index fell to 49.7 in June, the lowest since 2009, from 53.5 the prior month, based on data released July 2. The gauge of new orders also decreased to a three-year low of 47.8 from 60.1. Readings below 50 signal a contraction.

Since the ISM indexes are based on a survey of more than 400 industrial companies, investors look for “hard data” to confirm “how strong or weak the manufacturing side of the U.S. economy is,” Ghriskey said.

These data come from businesses such as Grainger, based in Lake Forest, Illinois, and Fastenal Co. (FAST), which distribute industrial supplies to a broad swath of customers, including manufacturers and hospitals.

Fastenal’s daily net sales grew 9 percent in May at stores more than five years old, which best represents the broader economy. The pace was the slowest since March 2010, according to figures from the Winona, Minnesota-based company. Meanwhile, U.S. daily sales were up 8 percent at Grainger, compared with as much as 12 percent in February, company data show.

Short Lead-Time

There’s a “very short lead time” in sales of products for manufacturing, so MSC Industrial Direct Co. (MSM) and its competitors tend to be a leading indicator of activity, President Erik Gershwind said in an interview. The company, based in Melville, New York, supplies metalworking, maintenance and repair goods -- the “stuff on or around a production floor” -- so if customers see a slowdown coming, “they can pull back on orders very quickly.”

Shipments probably have weakened for RockTenn, Packaging Corp. and International Paper, so “none of these companies are going to blow the lights out” when they report quarterly earnings, said Chercover, who maintains “buy” recommendations on them. The consensus estimate for Packaging Corp. is about 45 cents a share, up about 16 percent from a year ago.

For MSC Industrial, “activity levels remain solid, though there’s been some leveling or moderation” recently, Gershwind said. As a result, the company projected implied average daily sales growth of about 10.5 percent for the fiscal fourth quarter, which began May 27, based on the midpoint of its guidance range. This compares with a 15 percent rise in the three months ended May 26.

‘Feared Worse’

The forecast came June 28 when MSC Industrial reported third-quarter results. Its shares rose 4.3 percent that day, the most since November, an indication investors “feared worse,” said Ryan Merkel, an analyst with William Blair & Co. in Chicago. The stock was down almost 26 percent between March 28 and June 27, so the rebound suggests investors were relieved the company didn’t project significantly slower sales growth, he said.

“Manufacturing output is slowing but not contracting, which would be synonymous with a recession,” Merkel said.

ISM’s July 2 report “definitely was a negative” for these distributors, said Derek Jose, an analyst in Independence, Ohio, with Longbow Research. While shares of Fastenal, scheduled to announce earnings tomorrow, have risen 3.8 percent since MSC Industrial’s financial release, there’s “still some room for it to come down,” he said.

‘Considerable Miss’

Grainger’s stock has “held up pretty well compared to its peers” -- down about 1.4 percent so far this year -- so the company would need to report “a considerable miss” in second- quarter earnings for investors to become more pessimistic, Jose said. Grainger is scheduled to release its financial results July 18.

The ISM data and MSC Industrial’s comments indicate that sales in July and August, typically weaker months on average, “are likely to be even lower than we expected at the beginning of June,” Jose said. Still, “sales should continue to grow, but at a slower rate” -- one of the reasons he maintains “neutral” recommendations on Grainger and Fastenal.

The prospect for box shipments may not be as optimistic, based on conversations with so-called nonintegrated companies -- those that produce only boxes -- according to Mark Connelly, a senior analyst in New York at Credit Agricole Securities Inc. Three months ago, box-makers in New York, Maine, Ohio and Tennessee were “hopeful,” though more recently they’ve indicated business has weakened, he said.

Contraction Possible

While demand was strong in early 2012, it has slowed and a contraction is possible, he added. Investors already have discounted slower demand, as International Paper stock has fallen about 21 percent since March 13 and RockTenn is down almost 28 percent.

Still, “we’re not quite at the point where investors are pricing in a recession,” Connelly said.

If shipments were to contract more than 2 percent for a few months, that would indicate a higher probability of another slump, said Albert Kabili, an analyst in New York at Credit Suisse Group AG. Sustained growth above 1 percent would give investors more confidence in the outlook for demand and the expansion; just as important, it would suggest the industry could raise prices again, he said, adding this isn’t likely.

“I think we’re going to muddle along in the short term,” Kabili said. “As a result, I don’t think we’re going to get a price increase for the industry, which is the spark to lift stock prices higher.”

To contact the reporters on this story: Anna-Louise Jackson in New York at ajackson36@bloomberg.net; Anthony Feld in New York at afeld2@bloomberg.net

To contact the editor responsible for this story: Anthony Feld at afeld2@bloomberg.net

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