The manufacturing sector has held its ground this year despite impact from tariff and supply chain challenges. This momentum is likely to continue next year as well, supported by the spate of positive data coming in from the sector. Improvement in its end markets like residential and non-residential construction; mining driven by ongoing recovery in the commodities, oil and gas industry; and economic growth will continue to drive the sector.
Strong Manufacturing Data Despite Tariff Woes
The announcement of the tariffs on steel imports into the United States earlier this year was a big blow to the manufacturing sector overall. Given that steel is a primary raw material, every manufacturing company bore the brunt of rising steel prices owing to the tariffs. Though this was mitigated to some extent with price increases, it might not always be feasible to pass on the price increase to customers. Further, the industry has been plagued with shortage of skilled laborers, higher wage costs and flaring-up transportation expenses.
Despite these challenges, the manufacturing sector witnessed strong production output and continued strength in new orders this year. Per the Institute for Supply Management’s (“ISM”).latest report, Purchasing Managers’ Index (“PMI”) for November rose 59.3% — maintaining growth in manufacturing for the 27th consecutive months. Of the 18 manufacturing industries, 13 reported growth in November.
The PMI has averaged 59.2% over the last 12 months ranging from a low of 57.3% in April 2018 to a high of 61.3% in August 2018. Notably, a reading above 50% indicates expansion in manufacturing economy. The PMI reading of 59.3% for November corresponds to an increase of 4.9% in real gross domestic product (GDP) on an annualized basis.
New Orders Index registered 62.1% in November, indicating growth in new orders for the 35th consecutive month. Production Index registered growth of 60.5% in November, indicating improvement in production for the 27th consecutive month. Employment continued to expand, supporting production growth. The employment index was pegged at 58.4% in November, maintaining growth for the 26th consecutive month.
Additionally, industrial production — a measure of the level of output of manufacturing, mining and utilities sectors — rose 0.6% in November. Manufacturing output remained flat while mining output rose 1.7% aided by gains in oil and gas extraction, coal mining, and support activities for mining.
Sector Position & Performance
All the machinery industries are broadly clubbed under the Zacks Industrial Products Sector, one of the 16 broad Zacks sectors. The sector’s earnings rose 20% in third-quarter 2018. Per Zacks’ projections, the sector is expected to log growth of 14% in earnings in the fourth quarter of 2018. In the next fiscal, the sector’s earnings are expected to rise 7.4% in the first quarter, followed by 7.7% and 10.6% in the second and third quarters of 2019, respectively. (Read more: Handicapping the Q4 Earnings Season)
This sector has underperformed the S&P 500 market in recent times owing to the concern surrounding the impact of tariffs. In the past year, the sector has dipped 27.5% while the S&P 500’s declined 12.4%. We believe the price performance will eventually pick up, driven by the healthy growth prospects and upbeat numbers coming from the manufacturing sector which indicate that the sector is on a firm footing.
Continued improvement in residential and non-residential construction, and revival in infrastructure demand bode well for the industry. Mining companies are also resuming capital spending due to the improvement in commodity prices. Further, the recently passed tax reform is likely to act as a catalyst by expediting manufacturing investment in factories, new equipment and other capital goods.
We have zeroed in on four industrial stocks which have a Zacks Rank #1 (Strong Buy) or 2 (Buy) and a VGM Score of A or B. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Our research shows that stocks with an impressive VGM Score of A or B when combined with a Zacks Rank 1 or 2, offer the best upside potential. Further, these companies have healthy earnings growth expectations for fiscal 2018 and next.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Industrial Stocks to Bet on
DMC Global Inc. BOOM: Boulder, CO-based DMC Global engages in technical product and process businesses serving the energy, industrial, and infrastructure markets worldwide. This Zacks #2 Ranked stock has a VGM Score of B. It has gained 37% over the past year. The company has estimated long-term earnings growth rate of 20%. The Zacks Consensus Estimate for earnings for fiscal 2018 and fiscal 2019 reflect year-over-year growth of 1150% and 26%, respectively. The company also has recorded average positive earnings surprise of 42.16% over the trailing four quarters.
Cintas Corporation CTAS: Based in Cincinnati, OH, Cintas provides corporate identity uniforms and related business services. It currently has a Zacks Rank #2 and a VGM Score of B. Its shares have gained 5% over the past year. It has estimated long-term earnings growth rate of 12%. The Zacks Consensus Estimate for earnings for the current fiscal exhibits year-over-year growth of 24% while the same for the next fiscal is pegged at 12%. The company has delivered average positive earnings surprise of 6.81% over the trailing four quarters.
W.W. Grainger, Inc. GWW: Lake Forest, IL-based Grainger distributes maintenance, repair, and operating (MRO) supplies, and other related products and services. The stock has a Zacks Rank #2 and a VGM Score of A. The company has a long-term estimated growth rate of 12.4%. The Zacks Consensus Estimate for earnings projects year-over-year growth of 42% and 10% for fiscal 2018 and 2019, respectively. The company has delivered average positive earnings surprise of 19.7% over the trailing four quarters. Its shares have gained 17% over the past year.
Enersys ENS: Reading, PA-based Enersys manufactures, markets, and distributes industrial batteries. It has a Zacks Rank #2 and a VGM Score of A. The Zacks Consensus Estimate for earnings for the fiscal 2018 projects year-over-year growth of 10% while the same for the next fiscal is pegged at 18%. The company has delivered average positive earnings surprise of 2.8% over the trailing four quarters. The stock has gained 9% over the past year.
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