If you're waiting on the industrial turnaround, settle in -- it'll be a while.
It's several weeks into earnings season and very few of the largest U.S. industrial companies have had resoundingly positive news for investors. For some, such as General Electric Co., a decent showing profit-wise was obscured by sales disappointments. For others, inklings of improvements got undermined by unexpected messes.
W.W. Grainger Inc., a distributor whose results can be an indicator of what's to come for industrials, saw a spike in December sales, but signaled that momentum wasn't carrying through to January and took a raft of one-time charges in the fourth quarter. Ingersoll-Rand Plc had gangbuster organic growth and climate-product orders, but caught investors off guard when higher compensation and IT costs knocked a decent chunk off its EPS.
Few industrial companies thus far have seen significant stock gains following earnings announcements; most were down or flat. This reaction isn't overly surprising given all the optimism investors have pumped into manufacturing stocks. But even after the earnings-related moves, a Bloomberg Intelligence basket of industrial stocks has seen more than double the gains of the broader S&P 500 since the U.S. presidential election. Investors riding those gains should be prepared because there are likely to be at least a few more quarters like this last one: messy and underwhelming.
So far, major multi-industrial companies that gave 2017 EPS guidance ahead of their fourth-quarter earnings report haven't had to make major adjustments. That's a good thing, considering most of those projections were already a bit weak to begin with. Those that rolled out their annual forecast along with their quarterly results simply continued the trend. Pump maker IDEX Corp. and Ingersoll-Rand both delivered guidance ranges this week that fell short of analysts' expectations at the midpoint. Eaton Corp. delivered a 2017 forecast on Thursday that surpassed estimates, but that was largely because it pulled some restructuring costs into 2016 that otherwise would have reduced its EPS this year.
This isn't necessarily going to be a repeat of 2016, when companies banked on a second-half turnaround that never materialized and then had to roll back EPS outlooks. But there are some points of caution, such as the appearance of the margin pressure that analysts have feared would develop as recovering commodity prices drove up companies' material costs.
For six straight quarters, the spread between Ingersoll-Rand's selling prices and its material costs has swung in the company's favor, according to RBC analyst Deane Dray. That changed in the fourth quarter, with a 40-basis-point hit to its operating margin as price increases failed to keep pace with steel inflation. Ingersoll-Rand says it can remedy this in 2017, although it's already signaled its pricing edge will be weaker than typical. At the very least, eyes wide open is probably a good approach for this company and others with significant exposure to commodities inflation, such as Eaton, which also said rising raw material costs were causing headaches.
The bigger test is going to be whether these companies can meet their revenue guidance and finally start to rely on growth, rather than cost cuts and financial maneuvering, to drive profit improvements. There are already signs some might not be able to live up to the goals they laid out for themselves. Johnson Controls International Plc, for example, reported organic growth for its most recent quarter that missed analysts' estimates and forecast weak gains in the following period, making the path to achieving its sales guidance meaningfully more difficult if not impossible. GE's organic growth in the first and second quarters is going to get an extra dose of scrutiny in light of its ambitious forecast.
In the end, there's no reason to start ringing the alarm bell. Then again, the same thing could have been said at this time last year and it didn't work out so well, so...
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
One exception is perhaps Danaher Corp., but that company is something of a freak when it comes to earnings consistency and it's not really an industrial anymore after shifting its focus to life sciences.
Another thing that seems to be a one-time event (for now) was Grainger's decision to finally host a conference call in conjunction with its earnings release. The company wasn't willing to commit to making this a regular thing just yet. That's a mistake.
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