Equity investors are on tiptoe with the U.S. markets speculating the consequences of the air strike on Syria by the United States, Britain and France. This joint attack has left the world pondering over the ill-effects of the possible escalation in tension if Russia steps in. Also, imposition of tariffs on imports of steel and aluminium by the Trump government has soured trade relations with foreign nations, especially China. A trade war between the two economies will have adverse impacts as well.
Other than these burning issues, financial results for the January-March quarter of 2018 (or the first quarter) will be a major determinant of the movements in the U.S. equity market. So far, few banking stocks have failed to impress with their results, while major earnings releases are anticipated the next week.
Amid all these, it was the U.S. industrial production data that caught our attention.
What’s With the Industrial Production Data?
Industrial production measures the level of output of manufacturing, mining and utilities sectors in a country. It is considered one of the leading economic indicators for industrial machinery stocks.
Data released yesterday shows that U.S. industrial production in March 2018 grew 0.5% over the previous month while registering 4.3% increase from the year-ago month. This improvement, though is welcomed wholeheartedly, is half of 1% month-over-month gain and 10 basis points (bps) below the year-over-year growth of 4.4% registered in February.
The deceleration in growth is not only seen in the month’s data, but also in the quarterly numbers. In the first quarter of 2018, industrial production has grown at an annual rate of 4.5%, way below 8.2% recorded in the fourth quarter of 2017.
The sector’s monthly data reveals that manufacturing production was weak in March. It inched up a mere 0.1% compared with a 1.5% month-over-month gain recorded in February. At an annual rate, manufacturing production grew 3% in March.
Mining production too slowed in March, with month-over-month gain of just 1%. This improvement came in below 2.9% increase recorded in February. At an annual rate, mining production advanced 10.8% in March.
Utilities data came in as a surprise, having recovered from 5% month-over-month decline in February to 3% growth in March. At an annual rate, utilities increased 5.3% in March.
Capacity utilization in March jumped 30 bps to 78%.
Is It Time to be Wary About the Industrial Sector?
Apprehensions regarding weakness in industrial sector will be rife now. Many may interpret decelerating growth rates as the onset of a bad phase for the sector. We, however, are still optimistic.
Per our in-house classifications, the U.S. equity universe is grouped under 16 sectors. Industrial Products is currently at the top of the list. We believe that the sector as well as the U.S. economy is fundamentally strong to ward-off any adverse impacts arising from the worries that have gripped the market lately.
Earnings of the S&P 500 companies in the Industrial Products sector are projected to grow 19.9% year over year in 2018 compared with 18.7% recorded in 2017. The projections, as published in Earnings Trend on Apr 11, calls for margin growth of 1.02% in 2018, higher than 0.46% in 2017. A little disappointment is seen on the top-line front, with revenues likely to grow 8.2% in 2018, below 12.9% increase in 2017.
For the S&P 500 as a whole, earnings in 2018 are projected to increase 17.9% versus 9.7% in 2017. Margins will likely improve 1.26%, way higher than 0.2% last year. Revenue growth has gone down from 7.6% in 2017 to an expected 5.3% in 2018.
In the next three to five years, earnings of the Industrial Products sector are projected to grow 10.7%. This estimate is way higher than 1.4% earnings growth recorded in the last five years (2013-2017). Likewise, the S&P 500’s earnings are projected to improve 9.7% in the next three to five years, above 5.8% recorded in the last five years.
We see a lot of economic indicators pointing toward an expanding U.S. economy as well as growth prospects for industrial stocks. For instance, the ISM Purchasing Managers’ Index or manufacturing index data for March reflects an expanding manufacturing sector — as evident from growth in new orders, production activities, employment, new export orders and inventories. Also, the recent U.S. Census Bureau report shows that new orders for all manufacturing industries have grown 7.9% year to date. New orders of the machinery industry have increased 9.2% in the same timeframe.
Other supporting factors are the government’s policies, including the Tax Cut and Jobs Act, and its intention of investing heavily in infrastructure development among others. Job markets have strengthened, being at a 17-year low unemployment rate of 4.1% in March. The housing market is also on growth track with housing starts in March increasing 1.9% from the previous month.
On a broader note, the GDP of the United States grew 1.5% in 2016 and 2.3% in 2017. The International Monetary Fund (in its report issued in April) projects that the U.S. economy will advance 2.9% in 2018, reflecting a 20-bps hike over the previous estimates. Also, this premier institution expects the global economy to grow 3.9% in 2018 versus 3.8% in 2017. With growing interdependence among nations worldwide, overall growth in the global economy is considered favorable for a nation’s growth as well.
Suitable Investment Picks in the Industrial Sector
In the current scenario, we have zeroed in on four Industrial stocks that can be of interest to investors seeking exposure in the sector. A brief discussion on these stocks is provided below:
HD Supply Holdings, Inc. HDS: The company, with $7.2 billion market capitalization, is engaged in distribution of products in the industrial sector. Healthy end markets for its Facilities Maintenance and Construction & Industrial segments as well as gains from acquired assets and disposal of assets will be advantageous for the company.
It currently sports a Zacks Rank #1 (Strong Buy). Its investment appeal is further accentuated by a favorable VGM Score of B. Also, the stock’s industry is in the top 11% of the Zacks industry list. (To learn more visit: About Zacks Industry Rank)
Earnings for the next three to five years are anticipated to grow 15.7%, higher than the projection for the sector. Also, the company’s Zacks Consensus Estimate stands at $3.17 both for fiscal 2018 (ending January 2019) and fiscal 2019 (ending January 2020), reflecting growth of 11.6% and 17.4% from the respective figures 60 days ago.
Also, the company is likely to surprise earnings estimates in the first quarter of fiscal 2018 (ending April 2018) as it has an Earnings ESP of +0.18% and a favorable Zacks Rank. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.
Stocks having a combination of favorable Zacks Rank #1 or 2 (Buy) or 3 (Hold) and a positive Earnings ESP have higher chances of surpassing estimates in the quarter. You can see the complete list of today’s Zacks #1 Rank stocks here.
Rexnord Corporation RXN: The company primarily produces equipment used in water management and process and motion control. Healthy product demand, acquisitive nature and gains from its supply-chain optimization and footprint-repositioning programs will benefit it. Its market capitalization is $3.1 billion.
It has a Zacks Rank #2 and has a VGM Score of B. The industry it belongs to is in the top 18% of the Zacks industry list.
The company’s earnings for the next three to five years are anticipated to grow 12.4%. Also, the stock’s Zacks Consensus Estimate is currently pegged at $1.36 for fiscal 2018 (ending March 2018) and at $1.73 for fiscal 2019 (ending March 2019), reflecting growth of 2.3% and 1.8% from the respective figures 60 days ago.
Also, the company has an Earnings ESP of +4.36% for the fourth quarter of fiscal 2018 (ended March 2018). A likely positive surprise is expected in the quarter.
The Timken Company TKR: The company, with $3.6 billion market capitalization, is engaged in manufacturing and marketing various products, including couplings, bearings, industrial clutches and brakes and many more. Also, it provides related services to its customers.
It carries a Zacks Rank #2 and has a VGM Score of A. The industry it belongs to is in the top 15% of the Zacks industry list.
The company’s earnings for the next three to five years are anticipated to grow 11.6%. Also, the stock’s Zacks Consensus Estimate is pegged at $3.53 for 2018 and at $3.94 for 2019, reflecting growth of 9.3% and 7.4% from the respective tallies 60 days ago.
Also, the company has an Earnings ESP of +4.03% for the first quarter of 2018. A likely positive surprise is in store for the company this quarter.
A. O. Smith Corporation AOS: The company manufactures commercial and residential water heating equipment and water treatment products. Going forward, rising demand in water heater industry and in consumer products in China will be a boon. Its market capitalization is $11.2 billion.
It carries a Zacks Rank #2 and has a VGM Score of B. The industry it belongs to is in the top 18% of the Zacks industry list.
The company’s earnings for the next three to five years are anticipated to grow 12%. Also, the stock’s Zacks Consensus Estimate currently stands at $2.57 for 2018 and $2.89 for 2019. Also, the company has an Earnings ESP of +1.42% for the first quarter of 2018. A likely positive surprise is in store for the company this quarter.
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