Investors Gauge U.S. Output by Parker Hannifin: EcoPulse

Investors seeking confirmation of recent improvement in manufacturing activity will look to Parker Hannifin Corp. when it reports quarterly results next week.

Data from the maker of gears, pumps and valves are “one piece of the pie” investors consider to determine whether growth in capital-goods orders is sustainable, said Robert Pavlik, chief market strategist in New York at Banyan Partners LLC, which manages about $4.4 billion. That’s because the Cleveland-based company supplies equipment used in machinery, making it a “good, broader indicator” of industrial demand.

Orders for nondefense capital goods excluding aircraft and parts rose 9.7 percent in August from a year earlier, the biggest gain in 18 months, according to data from the Census Bureau, which is scheduled to release September figures Oct. 25. These orders have accelerated from a low of minus 0.8 percent in February, signaling a rebound in U.S. factory activity this year.

Pavlik is among a number of investors who are watching quarterly reports from manufacturers to see if they reflect the government-measured improvement. Jeff Hammond, an analyst with KeyBanc Capital Markets Inc. in Cleveland, said Parker Hannifin could echo the trend because the pace of its industrial-order growth is a “good proxy” for capital goods. The company is “pretty broadly diverse” in the markets it serves and the range of motion-control products it manufactures, he said.

Falling Orders

Parker Hannifin’s North American industrial orders fell 5 percent in the three months ended June 30 compared with a year earlier, the fourth consecutive quarter of contraction, based on company data.

Investors should pay particular attention to how Parker Hannifin executives describe the operating environment when they release fiscal first-quarter results, scheduled for Oct. 18, Hammond said. This will provide clues about the durability of the U.S. expansion, which appears to be “mending slowly,” Pavlik said.

Gross domestic product accelerated to a 2.5 percent annualized rate in the second quarter, after expanding 1.1 percent in the first quarter, according to the Commerce Department. The world’s largest economy will grow 2 percent in the third quarter, followed by 2.5 percent in the fourth, according to the median forecasts of economists surveyed by Bloomberg from Sept. 6 to Sept. 11.

Government Shutdown

Guidance from the company executives could be overshadowed by the U.S. government shutdown, which began Oct. 1. The political tensions that caused it may temper business investment, which means five consecutive months of annual gains in capital-goods orders might not be sustainable, said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. This measure of business activity contracted by as much as 6 percent last year and shrank in two of the first three months of 2013.

A one-week partial shutdown would trim 0.1 percentage point from economic growth, according to the median estimate of economists in a Bloomberg survey published last week, with the amount accelerating the longer the closing lasts.

Based on field checks Hammond conducts with business executives, he said they don’t anticipate demand will get any worse, as they’re “becoming numb” to the government problem of the day. That’s why he encourages investors to pay attention to the tone expressed by leaders of Parker Hannifin and other industrial manufacturers in the earnings season to see how the shutdown affects orders.

Improvement Starting?

Hammond said some executives have told him they’re hopeful that “better macro-data points” -- such as the capital-goods report -- will start to translate into an improvement.

Parker Hannifin has been experiencing a reduction in inventory, which probably will end in the “near term,” Chairman Donald Washkewicz said on an Aug. 6 conference call. “I would say we’re just now getting to probably the bottom of the destocking cycle.” The company declined to comment for this story.

On a calendar-year basis, Parker Hannifin’s 2013 sales will be essentially unchanged from last year -- $13.15 billion compared with $13.09 billion -- according to the consensus of analyst estimates collected by Bloomberg. That compares with about 5 percent sales growth for companies in the Standard & Poor’s 500 Index.

Higher Expenses

It reported fiscal fourth-quarter earnings on Aug. 6 of $1.78 a share, missing the consensus by about 9.4 percent because of “reduced volumes and greater than anticipated inventory, acquisition, integration and related expenses,” the company said in a statement. Meanwhile, sales of about $3.43 billion also were below the consensus estimate of almost $3.48 billion.

The stock has outpaced the S&P 500 by about 5.2 percentage points since then, as investors still have been “willing to pay more for it,” even after a weak quarter, said Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc. Last month Parker Hannifin traded close to relative highs set in 2012, and it’s been outperforming the market for the first time since 2011, he said. “That’s a sign of a positive trend change.”

There could be more gains to come because the stock has a “long-term track record” of rallying when demand is improving, said Hammond, who maintains a buy recommendation on the company. Even so, Parker Hannifin is facing easier comparisons ahead, so it’s “wait and see” if an increase in its North American industrial orders comes from accelerating output and sales, Hammond said.

‘Fiscal Shenanigans’

In addition, amid this year’s “fiscal shenanigans,” many companies continue to behave cautiously, so Pierpont’s Stanley isn’t “particularly optimistic that we’re on the cusp of a major improvement in capital spending.” While the recent increase in capital-goods orders provides “a little hope for the future,” there’s yet to be a similar bump in shipments, Stanley said.

As a result, even though Pavlik at Banyan Partners currently doesn’t hold Parker Hannifin, he still will pay close attention to the company’s earnings next week to see if there’s a shift under way.

“You have to look at order data in context with other indicators to get a sense of what’s really happening.”

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