Global Machinery Stocks, Piece by Piece - Industry Outlook

By Zacks | May 12, 2014 AAA

Prospects in the United States

The world’s largest economy holds approximately 17.1% of the global gross domestic product (GDP), on a purchasing power parity (PPP) basis, in 2012. Next in the ranking are China and India, with respective GDP share of 14.9% and 6.4%.

Machinery shipments increased by 2.9% in the initial three months of 2014, according to the U.S. Census Bureau report published in May 2014. Shipments for industrial and metalworking machinery rose by 22.2% and 8.7%, respectively, while that for farm as well as construction machinery fell by 6.3%. New machinery orders were up 6.4% while order backlog grew 9.2%.

Export demand has been considered a key factor for the U.S. machinery industry. In 2013, the country’s construction and agricultural equipment exports fell 25% and 6% year over year respectively, according to a report published by the Association of Equipment Manufacturers (AEM). However in the coming years, the U.S. is expected to witness growing international demand for technologically advanced construction and agriculture equipments.

Unemployment, though a continually disturbing factor, has showed signs of improvement in Apr 2014. As per the latest report by the Bureau of Labor Statistics, job additions in April were 288,000, increasing from 203,000 added in March. The unemployment rate has fallen 40 basis points (bps) to 6.3%. On an average, job additions in the last three months (April, March and February) were 238,000. This latest job report strengthens the view that the Federal Reserve will continue to taper its quantitative easing program.

Besides positive signs from the labor market, there is a glimmer of hope emanating from the evidence of growing demand in the housing as well as durable goods markets. Conditions in the credit markets are also improving slowly.

Japanese Markets

The recovery noticed in the Japanese economy in the past few quarters was primarily triggered by economic policies undertaken by the government, recovery in capital spending and higher machinery orders from private sector and manufacturing industries. The country increased its sales tax by 3% effective Apr 2014, with a view to curb its growing debt levels. This measure is expected to drive growth in the medium to long term.

However, the latest report by Japan’s Cabinet Office shows that total machinery orders in Feb 2014 fell 5.9% from the prior month. Private-sector machinery order (excluding volatile orders from ships and electric power companies) or core machinery order were down by 8.8%, raising concerns over the future of capital investments by companies. Orders from governments and overseas clients increased 6.2% and 2.4%, respectively.

The weak order trends and the nervousness regarding the impact of sales tax hike on demand of goods compelled the Bank of Japan to lower its real GDP growth forecast to 1.1% for fiscal 2014 (ending Mar 2015), from the earlier expectation of 1.4%. Also, the IMF has lowered its growth forecast for the economy by 30 bps to 1.4% for 2014.

Emerging Nations

China: The Chinese government is focused on rapid urbanization, and has planned major investments accordingly. Domestic demand is strong in the country while exports are also on the rise. Further, efforts in improving trade relations with Brazil, Russia and other countries are expected to boost growth.

The world’s second largest economy recorded a 0.8% year-over-year increase in its foreign trades in Apr 2014. Exports were up 0.9% while imports grew 0.8%. Trades with the European Union and the U.S. increased 8.5% and 2.4% respectively, in the first four months of 2014. Industrial production in Mar 2014 increased 8.8% over the year-ago month.

Growth in 2014 is expected to be driven by investments and a rise in demand from the advanced economies. The IMF anticipates the Chinese economy to grow by 7.5% in 2014 and 7.3% in 2015.  

India: Industrial production in India decreased 1.9% year over year in Feb 2014, mainly due to weak manufacturing output. According to the IMF, the country is projected to grow 5.4% in 2014 and 6.4% in 2015. Rising domestic and external demand, expectation of policy improvements and better monsoon conditions are the primary drivers of the country’s growth.

Brazil: The country, with a population of over 200 million, is growing fast as the favorable destination for foreign direct investments. Industries like tourism, steel and electricity, among others, are gaining strength and promise robust growth.

The Brazilian government, under its Growth Acceleration Program, or PAC – phase II, has planned major investments for the development of ports, railroads, airports, wind farms and roads. Other areas of focus are sanitation, energy and logistics. Also, to promote its export businesses with other countries, roughly 24 Free Trade Zones (FTZ) is being set up across 20 Brazilian states.

However, the outlook for 2014 is a bit gloomy owing to low private investments and inadequate infrastructure. The IMF has lowered its growth forecast on the country to 1.8%, down 50 bps from its prior estimate. In Mar 2014, the country’s industrial production fell by 0.9% year over year.

South Africa: The government is focused on improving its mining, manufacturing chemicals and agricultural sectors. Huge public investments have been announced under the infrastructure development programs. Also, the country is keen on expanding its trade relations with its largest exporter-importer country, China. The IMF expects the country to grow by 2.3% in 2014 and 2.7% in 2015.

In fourth-quarter 2013, GDP grew by 3.8% over the year-ago quarter, while in Mar 2014, industrial production was up by 0.7% over the prior-year month.

Other Major Players

Korea: Industrial production in Mar 2014 increased 2.8% from Mar 2013, according to the latest data released by Statistics Korea. The country seems to be recovering slowly from the impacts of weak exports caused by uncertain economic conditions in the Eurozone.

Thailand: The country is making huge investments, both domestic and foreign, to improve its service and public utilities, metal products industries as well as machinery and transport equipment-related industries. To further enhance its exports, the government is laying emphasis on infrastructural developments and free trade agreements.

Industrial production declined 10.4% in Mar 2014 from the year-ago period, as reported by the Office of Industrial Economics. The disappointing result points towards weakening domestic demand.

Eurozone — Showing Signs of Improvement

The Eurozone’s industrial production (excluding construction) in Feb 2014 inched up by 0.2% from Jan 2014 while rising 1.7% year over year, according to data released by the Eurostat in Apr 2014.

According to the VDMA Machine Makers’ Association, German machine tool orders in Jan 2014 increased 6.0% year over year. Domestic orders were up 2% while international orders grew 7%.

Zacks Industry Rank

Within the Zacks Industry classification, Machinery is broadly grouped into the Industrial Products sector, one of the 16 broad Zacks sectors.

More than 260 industries are ranked in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, industries with Zacks Industry Rank of #88 and lower are considered to have a positive outlook, those between #89 and #176 have a neutral outlook while the ones with #177 and higher possess a negative outlook.

The machinery industry is further sub-divided into five industries at the expanded level: Machine Tools and Related Products, Machinery – Construction and Mining, Machinery – Electrical, Machinery – Farm and Machinery – General Industries.

The Zacks Industry Rank for Machine Tools and Related Products is #94, Machinery – Construction and Mining is #95, Machinery – Electrical is #97, Machinery – Farm is #98 and Machinery – General Industries is #99. Considering the Zacks Industry Rank of all the machinery related industries, it can be deduced that the sub segments of the machinery industries have a neutral outlook.

Earnings Trend of the Sector

Results for the Industrial Products sector in first-quarter 2014 provided little reason for the investors to rejoice. Roughly 84% of the sector’s companies in the S&P 500 group reported 9.3% year-over-year growth in earnings till May 9, 2014. Earnings beat ratio (percentage of companies coming out with positive surprises) was 66.7%. Revenues edged down 0.7% year over year with a beat ratio of just 18.2%.   

The earnings growth path is a bit erratic for the sector, as after a 9.3% earnings growth for the first quarter, only a marginal increase of 0.8% is expected for the second quarter. Second half of 2014 is likely to experience a 3.8% earnings growth in the third quarter and 8.7% in the fourth quarter. For the full-years 2014 and 2015, earnings growth are anticipated to be 7.8% and 12.3% respectively.

For the top line, a wider fall of 1.5% is projected in the second quarter. Thereafter, revenues are likely to inch up 0.7% in the third quarter and 1.3% in the fourth quarter. For the full-years 2014 and 2015, revenues are predicted to rise 0.1% and 4.1% respectively.

In view of all the Zacks sectors combined, total earnings growth rate in first-quarter 2014 is anticipated to be 1.2%. Revenue growth is predicted at 0.9% with a modest gain expected in margins.

For more information about earnings for this sector and others, please refer to our 'Earnings Trends' report.

Important Players in the Machinery Industry

Deere & Company (DE) is a $34.9 billion company operating in the farm machinery industry.

Caterpillar Inc. (CAT) is a $65.6 billion company operating in the construction and mining machinery industry. The company has recorded a 5.5% earnings growth in the past five years versus a meagre 1.30% for the industry. Year-to-date return has been recorded at 21.7%. Prospects are bright for the company as earnings are anticipated to rise 10.10% in the next five years.

Other top players in the agricultural, construction and mining machinery industries include AGCO Corporation (AGCO), Toro Co. (TTC), Terex Corp. (TEX) and Kubota Corporation (KUB).

Prime companies operating in machinery industries other than agricultural, construction and mining are Rockwell Automation Inc. (ROK), Illinois Tool Works, Inc. (ITW) and Manitowoc Company, Inc. (MTW), among others. Of these, Illinois Tool Works is a $35.6 billion industrial tool maker. The company’s earnings in the past five years have grown by 5.00% and is expected to increase 9.30% in the next five years. Year-to-date, the company has yielded a solid return of 29.0%.

OPPORTUNITIES

Fiscal government expenditures play a counter-cyclical role curbing the ill effects of slower economic development and a tight credit market. China’s structural stimulus package, government spending on social welfare, construction of low-cost housing and completion of infrastructure projects on agriculture, forestry and water resources received special attention.

Moreover, the U.S. Congress had a stimulus package designed in 2009 that had money flowing into infrastructure spending. Also, The American Energy & Infrastructure Jobs Act (H.R. 7) will boost spending in infrastructure projects. Approximately $260 billion will be allocated to fund roads, bridges and highway projects over five years.

WEAKNESSES

We remain wary of the rising raw material costs of some of the major players of the machinery industry. Steel prices along with energy, especially coal and fuel prices, remain the prime causes for concern.

Research and development costs are also on the rise for machine makers as they seek to manufacture more sophisticated and technologically advanced machinery. Availability of funds remains a stumbling block as some major nations are still struggling to stabilize their own economies.

Although favorable commodity prices are a boon, government policies affecting prices along with export and import policies and trade relations with other countries will influence the machinery industry at large.

To Conclude: Prospects are Bright

Despite economic uncertainties still persisting in many parts of the world, efforts for implementing better policies, growing trade relations and an escalating population are prime catalysts driving the demand for better infrastructure, modernized methods of agriculture and mining/manufacturing tactics. All these will eventually boost the demand for technologically advanced equipment in these industries. Moreover, looking ahead, the growth path widens for the emerging and developing nations, which will inevitably become rewarding destinations for machine makers worldwide.

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