U.S. Markets closed

Industrial Pressure Points Pile Up in Trade War

Brooke Sutherland

(Bloomberg Opinion) -- We are another week older and seemingly none the wiser when it comes to President Donald Trump’s various trade wars, but troubling data points are piling up for industrial companies.

Mexico’s foreign minister, Marcelo Ebrard, traveled to Washington this week to persuade the Trump administration to drop its plan to impose sweeping 5% tariffs on imports from the country. But no deal emerged from conversations on Wednesday; a meeting Thursday ended in a similarly disappointing fashion; and Trump seemed to imply Friday that he was also seeking agricultural purchasing commitments, despite previous tying the tariffs to immigration issues. Senate Republicans, including Majority Leader Mitch McConnell, are reportedly pushing back on the tariff plan, although it remains unclear whether they’re prepared to take bolder action beyond grumbling behind closed doors. Also unclear is what kind of concessions from Mexico on immigration would actually persuade Trump to change course or whether U.S. surrogates are able to negotiate anything meaningful while he’s touring Europe. There’s a glimmer of hope that Mexico’s willingness to take Trump’s demands seriously could inspire a delay in the tariffs or at least make them short-lived. Autos and agriculture are obvious victims if the tariffs do take hold, but the HVAC, lighting and pump and valve industries also rely heavily on Mexican imports, potentially putting names like Lennox International Inc., Hubbell Inc. and Flowserve Corp. in the crosshairs. 

Separately, Trump said he would decide whether to put tariffs on the $325 billion of Chinese imports that haven’t yet been targeted after meeting with President Xi Jinping later this month at the G-20 summit. The industrial world got a glimpse of what additional retaliation from China might look like, should that last-ditch face-to-face fail. Over the weekend, China announced an investigation into FedEx Corp. after the parcel-delivery company diverted packages bound for Huawei Technologies Co. offices in China. The rerouting was reportedly caused by changes FedEx made to internal protocols after the Trump administration banned the sale of American technology to Huawei. Ford Motor Co.’s main joint venture in China was then accused of antitrust violations and fined about $24 million. Addressing the Electrical Products Group Conference in May, General Electric Co. CEO Larry Culp probably spoke for a lot of industrial CEOs when he said he’s more worried about these kinds of “subtle repercussions” than direct cost increases from the tariffs, which he’s put at $400 million to $500 million for GE in 2019.

One notably less subtle repercussion is the toll this trade uncertainty appears to be taking on the manufacturing economy. The Institute for Supply Management’s gauge of U.S. factory activity, while remaining at a level that signals an expansion last month, dropped more than economists expected to the lowest level since October 2016. A separate U.S. manufacturing index from IHS Markit also released this week showed the industrial economy was teetering on the brink of a contraction in May as new orders declined for the first time since August 2009. Industrial distributor Fastenal Co., whose results can often be a harbinger of what’s to come at its manufacturing customers, reported a 9.5% increase in daily sales for May, a recovery from a weaker-than-expected April but a slowdown from the double-digit pace management had been expecting to continue through the year. Cars and electronics remain the biggest black eyes in the industrial economy, and on that front China unveiled a stimulus plan this week to bolster domestic demand. But the proposed support is less robust than previous drafts and doesn’t include spending by the central government, so it’s unclear how much of an uplift that will have. The Federal Reserve may also be moved to add stimulus by cutting interest rates after Friday’s jobs report showed U.S. employers added just 75,000 workers in May, the fewest in three months. A reduction may come too late, though, to stave off a continuing slump in the automotive industry and pressure on housing sector, argues my Bloomberg Opinion colleague Danielle DiMartino-Booth. Of note, U.S. industrial companies have announced nearly 45,000 job cuts so far this year, up 671% from the same period in 2018, while automotive headcount reductions have swelled to the highest five-month total since 2009, according to data from Challenger, Gray & Christmas Inc. Basically, hold on to your hats because this industrial slowdown risks becoming worse — and perhaps turning into an outright downturn — before things gets better. 

YOUR AMAZON PACKAGE HAS BEEN REROUTEDFedEx announced Friday afternoon that it had made a “strategic decision” to not renew its U.S. air-delivery contract with Amazon.com Inc. The decision doesn’t affect Amazon’s contracts with FedEx’s ground operations nor its international services. This is unlikely to be a huge direct financial hit for FedEx; the company noted Amazon represented less than 1.3% of its total sales across all units in the 2018 calendar year. One way to read this is FedEx finding a bit of a backbone on pricing and pushing back on Amazon’s demands for ever-lower prices and ever-faster delivery to protect its margins from further declines. Another is that FedEx finally views Amazon’s burgeoning home-grown logistics arm as a credible competitive threat despite all the protestations from CEO Fred Smith to the contrary over the past few years.

BOEING BLUESEscalating trade tensions haven’t yet scuttled Chinese airlines’ interest in an order for 100 wide-body Boeing Co. jets, according to Bloomberg News. The deal could be worth more than $30 billion, depending on the final mix of 787 Dreamliners and the new 777X plane. That’s before taking into account customary discounts, which could widen in this case as the Chinese undoubtedly realize how much a victory like this would mean for Boeing with its 737 Max still idling on the ground. While I can’t think China is particularly incentivized to bolster Boeing’s credibility right now and hand a victory to the Trump administration, the fact that the planemaker hasn’t yet been targeted with the kind of retaliation that’s being meted out to FedEx and Ford is a testament to how much Boeing and China still need each other. “Yet” is the key word there, and the outcome of these negotiations will be closely monitored.

Boeing CEO Dennis Muilenburg continued his sort-of-apology tour with an interview on CNBC this week. To me, at least, it felt a bit overpracticed, like his other recent on-air appearances. Asked about rebranding the Max, Muilenburg said returning the plane to the skies isn’t “a PR process or an advertising process. This is about safe travel.” He’s right, of course. Safety should be Boeing’s top priority, and, in theory, the rebuilding of customer confidence should flow from that. But it seems as if Boeing and its investors continue to underappreciate the risks of consumer backlash while overestimating the willingness of airlines to do the heavy lifting on restoring the reputation of both the plane and its manufacturer. At least 20% of U.S. travelers say they would definitely avoid the Max for its first six months back in service, while more than 40% said they would be willing to take pricier or less convenient alternatives, according to an Atmosphere Research Group survey published this week. Consumer advocate Ralph Nader, whose grandniece died in the Ethiopian Airlines crash, has argued that the Max should never fly again and that Boeing leaders should resign. With the grounding of the Max soon entering its third month, Boeing’s suppliers are feeling more of a pinch. Spirit AeroSystems Holdings Inc. is reducing its workweek to 32 hours, a labor union representative told Reuters Friday. CFM International, the engine joint venture between GE and Safran SA, is reportedly curtailing output by about 5% and is prepared to cut further if the grounding lasts beyond August. 

GE TIDBITSBoeing’s CFO Greg Smith also spoke this week at a UBS conference and threw GE under the bus, saying the company’s engine is the “long pole in the tent right now” holding up the first flight of its 777X jet. GE told Aviation Week that it uncovered an “anomaly” in the engine’s high-pressure compressor in testing and that the issue is mechanical rather than aerodynamic. It’s not a great development for GE, with investors still jittery over the uncovering of durability issues with its flagship H-class gas turbine, but this seems like a true teething issue. It’s better to make tweaks while still in the testing process than have to upgrade planes already in the sky, like United Technologies Corp. had to do with its GTF engine. Boeing says it still expects the 777X to enter service in 2020. More concerning is a report from Reuters that the U.S. Securities and Exchange Commission is investigating GE’s health-care unit, along with those of Siemens AG and Royal Philips NV, for allegedly using middlemen to negotiate bribes with government and hospital officials in China. This follows reports of a similar investigation in Brazil. The companies have denied wrongdoing, but some investors still question why GE decided to scrap the health-care IPO it spent months planning in favor of the $21.4 billion sale of its biopharma unit to Danaher Corp. at an arguable discount. CFO Jamie Miller, speaking at a Deutsche Bank AG conference this week, said the health-care unit is treated as a core part of the company from an operational standpoint and “time will tell” whether a divestiture of the remainder eventually makes sense. Elsewhere, the Wall Street Journal’s profile of a notable GE bear, JPMorgan Chase & Co. analyst Steve Tusa, is worth a read, and not just for the details about his elaborate annual beer pong tournament. It says a lot about management’s supposed commitment to transparency that time that could have been used to fix GE’s problems was reportedly instead devoted to hunting for potential leaks to an analyst who was accurately calling the company out on its shortcomings.  DEALS, ACTIVISTS AND CORPORATE GOVERNANCEFortive Corp. is paying $570 million to acquire Intelex Technologies, a maker of software that helps companies manage environmental compliance, workplace safety and quality control. Financial details for private-equity backed Intelex weren’t disclosed, but Gordon Haskett’s John Inch estimates Fortive paid just more than 7 times sales. The Intelex purchase will be integrated into Fortive’s Industrial Scientific subsidiary, a business that got its start as a gas-detection equipment company but has since expanded into connected sensors and analytics. The Internet of Things movement thus far has primarily focused on using data harvested from equipment to improve operations or reliability; Fortive and Intelex think there’s an opportunity to also use that information to improve how businesses handle environmental and safety issues. Fortive acquired Industrial Scientific in 2017, a year after its spinoff from Danaher, in the first of many deals designed to bolster its industrial software platform. Intelex would seem to fit with that strategy. I just wonder whether Fortive is moving too fast for its own good. Including Intelex, it has now spent about $7 billion on deals in its short life as an independent company, according to data compiled by Bloomberg. Last year, Fortive closed on a Reverse Morris Trust divestiture of its automation and specialty products platform.

3M Co. agreed to sell its gas- and flame-detection business to Teledyne Technologies Inc. for $230 million. The purchase price works out to just shy of 2 times the $120 million of annual revenue produced by the assets, which 3M acquired through its $2 billion takeover of Scott Safety in 2017. RBC analyst Deane Dray says the multiple seems fair for a profitable niche testing business, but the fact that it’s a discount to the 3.5 times sales that 3M paid for all of Scott Safety is a sign that this particular part of the company had lower margins and sales growth. 3M risked a credit-rating cut as slumping automotive and electronics markets pressured its earnings, and CEO Michael Roman decided to undertake the company’s biggest deal yet in the $6.7 billion purchase of wound-care company Acelity Inc. The cash from this divestiture should help at the margin. More asset sales are likely coming: 3M is reshuffling its businesses into new operating segments and that organizational revamping is likely to shake out ill-fitting products that are better off elsewhere. Bombardier Inc.  is in talks to sell its CRJ regional jet program to Mitsubishi Heavy Industries Ltd. This would continue the unwinding of the company’s commercial aircraft operations, with Bombardier having already handed over a majority stake in its C Series jet to Airbus SE in exchange for the larger planemaker’s sales and operating expertise. Bombardier is also selling its Q Series turboprop program to Longview Aviation Capital Corp. for $300 million and is seeking a buyer for a wing-making operation based in Ireland — both Airbus and Spirit AeroSystems have said they’re looking at the assets —  as CEO Alain Bellemare tries to refocus the company and overcome weak cash-flow forecasts. The CRJ divestiture would leave Bombardier with two primary divisions: business jets and rail equipment. Citigroup Inc. analyst Stephen Trent estimates a sale could generate gross proceeds of $680 million for Bombardier, while Bloomberg Intelligence figures a range of $400 million to $900 million is appropriate, based on the valuation implied by Boeing’s investment in Embraer SA’s competing regional jet program. But Mitsubishi may be getting cold feet after news of the talks sparked a sharp sell-off in its shares. Investors aren’t keen on the company taking on another regional jet program when the one it’s already got has been prone to delays and cost overruns. Mitsubishi wanted to carve out just the aircraft maintenance network of the CRJ program, but Bombardier is insisting the unit be sold in its entirety, if at all, according to Nikkei.  Fiat Chrysler Automobiles NV has dropped its proposal to merge with Renault SA, pointing the finger at delays by the French government that gave the company the impression politicians were trying to wrangle more control over the combined entity. Both Fiat and the French government left the door open for talks to resume. Crucial to doing so may be getting Renault’s alliance partner Nissan Motor Co. more officially on board. The failed negotiations have reminded investors that Fiat was behind the curve on investing in electric vehicles and called attention to the fact that the stock market values Renault’s core car-making operations at essentially zero, my Bloomberg Opinion colleague Chris Bryant wrote. There are easier ways to fix those problems than a complicated merger of equals, as exemplified by the electric-car collaboration announced by BMW AG and Jaguar Land Rover Plc this week. But Fiat and Renault have already done most of the legwork on their proposed merger, with agreements on valuation, governance and jobs. A deal between Fiat and Peugeot SA may be just as politically fraught and a more challenging cultural fit. So Fiat and Renault may find the best path forward is to return to the negotiating table, wrote my Bloomberg Opinion colleague Chris Hughes, who posits that giving the French government a board seat may satisfy its angst.Crane Co. said it’s willing to increase its $45-a-share offer for Circor International Inc., dangling the prospect of an even juicier carrot for shareholders of the would-be target. Circor’s biggest investor is Mario Gabelli’s Gamco Investors Inc., and he isn’t particularly thrilled with its corporate governance practices and the lack of transparency on Crane’s offer. Circor must be feeling the pressure because it announced this week that it will provide an update “soon” on its efforts to improve growth, increase margins and strengthen its balance sheet. Ambitious financial targets rolled out in the face of an unwanted bidder tend to be rife with empty promises. My question for Circor would be why it took a public bid from Crane to inspire management to get more aggressive in making operational improvements and why shareholders should give them another shot at fixing things after years of underperformance.BONUS READING Oil Giants’ Chemical Lifeline Threatened by Plastic-Trash Crisis Goldman Says MedTech Tools Draw Investors Away From Industrials Six Flying Robotaxis That May Soon Take You From Midtown to JFK Big Carpet Wants to End America’s Love of Hardwood Floors Multinationals Are the World’s Bogeymen Again: David Fickling Markets Cheer a PG&E Plan; Ratepayers May Not: Liam DenningIf you’d like to get these weekly industrial insights delivered to your inbox, please email me directly at bsutherland7@bloomberg.net, and ask to join the list. Thanks!

To contact the author of this story: Brooke Sutherland at bsutherland7@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

For more articles like this, please visit us at bloomberg.com/opinion

©2019 Bloomberg L.P.