Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Another day, another industrial company lowering its earnings guidance.

On the heels of cuts by Dover and Honeywell, Tuesday's bearer of bad news is W.W. Grainger, a $12.3 billion supplier of motors, fasteners and other industrial parts. The company reduced the midpoint of its 2016 earnings-per-share forecast by about 15 cents and called for weaker revenue growth, even as third-quarter results surpassed analysts' estimates. Margins continued to erode as the commodity downturn and industrial slowdown limits Grainger's ability to raise prices for customers.  

Womp, Womp
Grainger's stock has fallen as the outlook on the industrial economy darkens.
Source: Bloomberg

Because Grainger supplies the construction, industrial and commercial sectors, its results are watched as a potential harbinger of what's to come when its customers report their own earnings. If the takeaway from the second quarter was that things in the industrial economy might get a bit worse before they get better, it now appears that the getting-better portion of this process will be pushed even further into the future.

The second-half turnaround so many industrial companies banked on when they rolled out their 2016 forecasts around this time last year may not materialize -- or, if it does, the beneficiaries will be few and far between.

Grainger said demand will continue to be "challenged" in the fourth quarter. October sales growth to date is slightly below what it saw in September, when company-wide revenue was essentially flat versus the prior year. Investors were not impressed by this update, sending Grainger shares down by as much as 5.1 percent on Tuesday. The industrial distributor's stock had already fallen about 6 percent over the past week and a half as industrial guidance cuts started to pile up.

Let's Take a Chill Pill
Grainger's Ebitda multiple has gotten somewhat more reasonable in the wake of Tuesday's guidance cut.
Source: Bloomberg

On the bright side, the decline has helped bring Grainger's valuation down to earth. It now trades at about 9.3 times its projected 2017 Ebitda, putting it at a slight discount to its five-year average. The company's stock is now well below analysts' average price target, giving it more margin for error and room to surprise investors should its business eventually start to turn around. 

But Grainger is still not an overly cheap stock, and it remains an open question what lies ahead for the company and the broader industrial sector in 2017.

Grainger rival Fastenal said last week it can't yet see a bottom for the industrial economy. Among its top 100 customers, 50 saw growth and 50 saw contraction in the third quarter. The typical ratio is more like 3 to 1, the company said. Data released this month showed output at U.S. manufacturers and total industrial production increased in September after contracting in August, but the recovery is fragile at worst and slow-going at best.

Living on a Prayer
Investors have been willing to take a gamble on struggling industrial companies as they bet on an eventual turnaround and enjoy the dividends many of these companies pay.
Source: Bloomberg

Grainger may be more reasonably valued for now, but many industrial companies are still trading at inexplicably high multiples. The broader S&P 500 Industrial Index is valued at about 9.8 times its members' projected 2017 Ebitda, more than a full turn above its five-year average. The earnings season is yet young, and more shoes are going to drop. Goldman Sachs analyst Joe Ritchie last week highlighted Flowserve and Rockwell Automation as among the most likely to cut their 2017 outlooks below Wall Street's estimates.

Investors would be wise to gird themselves for more disappointment.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net