The imposition of tariffs on steel imports into the United States last year dealt a massive 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. Despite this setback, the manufacturing sector held its ground and witnessed strong production output and strength in new orders last year. It seems well poised to sustain the momentum this year as well, supported by improvement in its end markets like residential and non-residential construction; mining driven by ongoing recovery in the commodities, oil and gas industry; and overall economic growth. Further, manufacturers have increased capital spending and hiring driven by massive tax overhaul, deregulatory measures and strong domestic economy.
Manufacturing Sector Firing on All Cylinders
Per the Institute for Supply Management’s (“ISM”) latest report, Purchasing Managers’ Index (“PMI”) for February rose 54.2% after a 56.6% reading in January. In fact, the sector has maintained the growth rate for 30 consecutive months. Of the 18 manufacturing industries, 16 reported growth in February.
The PMI has averaged 58% over the last 12 months ranging from a low of 54.2% to a high of 60.8%. Notably, a reading above 50% indicates expansion in manufacturing economy. The PMI reading of 59.3% for February corresponds to an increase of 3.3% in real gross domestic product ("GDP") on an annualized basis.
New Orders Index registered 55.5% in February, indicating growth in new orders for the 38th consecutive month. Production Index registered growth of 54.8% in February, indicating improvement in production for the 30th consecutive month. Employment continues to expand, supporting production growth. The employment index was pegged at 52.3% in February, maintaining growth for the 29th consecutive month.
Additionally, industrial production — a measure of the level of output of manufacturing, mining and utilities sectors — rose 0.1% in February. Manufacturing output fell 0.4% while output of utilities rose 3.7%. Mining output rose 0.3% — its 13th consecutive monthly increase aided by gains in oil and gas extraction, coal mining, and support activities for mining.
Sector Performance & Projections
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 25.5% in 2018 which was commendable considering the input cost inflation owing to tariffs. Per the latest Earnings Trends report, the sector is expected to log growth of 3.4% and 10.2% in earnings in 2019 and 2020, respectively.
In 2018, the Industrial Products sector had underperformed the S&P 500 market owing to the concerns surrounding the impact of tariffs. In 2018, the sector witnessed a decline of 7.6% while the S&P 500 rose 4.7%. However, the sector has fared better so far this year, notching a year-to-date gain of 15.6% compared with the S&P 500’s climb of 13.1%. We believe this price performance will be sustained this year, 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 on account of 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.
Moreover, the manufacturing companies continue to combat cost inflation through pricing actions as well as cost controls, increasing productivity and eliminating waste. Further, any positive development on the United States-China trade war front will be highly beneficial for this sector.
Industrial Stocks to Bet on
We have zeroed in on five 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 2019 and next. The chart below shows price performance of our five picks so far this year.
You can see the complete list of today’s Zacks #1 Rank stocks here.
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 A. It has gained 37% year to date. The company has estimated long-term earnings growth rate of 20%. The Zacks Consensus Estimate for earnings for fiscal 2019 and fiscal 2020 reflect year-over-year growth of 23% and 31%, respectively. The company also has recorded average positive earnings surprise of 48.2% in the trailing four quarters.
Avery Dennison Corporation AVY: Based in Glendale, CA, Avery Dennison produces and sells pressure-sensitive materials worldwide. . It currently has a Zacks Rank #2 and a VGM Score of B. Its shares have gained 25% year to date. It has estimated long-term earnings growth rate of 7%. The Zacks Consensus Estimate for earnings for the current fiscal exhibits year-over-year growth of 8.4% while the same for the next fiscal is pegged at 9.4%. The company has delivered average positive earnings surprise of 3.63% in the trailing four quarters.
Terex Corporation TEX: Westport, CT-based Terex manufactures and sells aerial work platforms, cranes, and materials processing machinery worldwide. The stock has a Zacks Rank #1 and a VGM Score of A. The company has a long-term estimated growth rate of 9.4%. The Zacks Consensus Estimate for earnings projects year-over-year growth of 39.5% and 3.8% for fiscal 2019 and 2020, respectively. The company has delivered average positive earnings surprise of 14.8% in the trailing four quarters. Its shares have gained 20% year to date.
H&E Equipment Services, Inc. HEES: Baton Rouge, LA-based H&E Equipment operates as an integrated equipment services company. It has a Zacks Rank #2 and a VGM Score of A. It has estimated long-term earnings growth rate of 15.2%. The Zacks Consensus Estimate for earnings for the fiscal 2019 projects year-over-year growth of 8% while the same for the next fiscal is pegged at 3%. The company has delivered average positive earnings surprise of 16.97% in the trailing four quarters. The stock has gained 28% year to date.
Hubbell Incorporated HUBB: Shelton, CT-based Hubbell designs, manufactures, and sells electrical and electronic products in the United States and internationally. The stock has a Zacks Rank #2 and a VGM Score of A. It has gained 22% year to date. The company has estimated long-term earnings growth rate of 10%. The Zacks Consensus Estimate for earnings for fiscal 2019 and fiscal 2020 reflect year-over-year growth of 11% and 10%, respectively. The company also has recorded average positive earnings surprise of 4.60% in the trailing four quarters.
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