Manufacturing Tools Industry's Near-Term Outlook Lacks Luster

The Zacks Manufacturing-Tools & Related Products industry comprises companies that develop and distribute hand and mechanics tools, hydraulic tools, engineered fastening systems and motion control systems. Arc welding products, oxy-fuel cutting equipment, plasma cutters, storage system and many related products are also produced by some tool makers.

The highly advanced tools are used in industrial, commercial, oil & gas, mining, automotive, and other industries. Providers of electronic security solutions cater to demand in the commercial, retailers, government, financial and healthcare markets.

Here are the industry’s three major themes:

• Demand in the industry is being driven by rising use of sophisticated technologies in manufacturing process, increased investments in infrastructural development and proactivity in new construction and remodeling. Moreover, the growing adoption of e-retailing has created business opportunities for tool makers. Added to these, favorable changes in tax policy, introduced in December 2017, worked wonders for corporates in the United States and industrial companies were not left out. Over the last five years (2014-2018), the industry’s revenues witnessed a compound annual growth rate of 3.5%.
  

• Increase in industrial production in the country is seen as a positive for tool makers. For January and February 2019, industrial production in the United States grew 3.9% and 3.6%, respectively. However, the decelerating rate of growth is concerning. Also, global uncertainties, trade tensions among foreign nations, especially the United States and China, and other headwinds have dimmed growth prospects of the global economy. The International Monetary Fund has lowered its growth projection of the global economy by 20 basis points (bps) for 2019. The U.S. economy is now projected to grow 2.3% in 2019, down 20 bps from the previous expectation. Also, unfavorable movements in foreign currencies may impede top- and bottom-line growth.
  

• Industrial tool makers are currently dealing with the adverse impacts of disturbed trade relations of the United States with other nations. Imposition of tariffs on the import of steel, aluminum and an array of other products triggered the tensions. Tariffs have escalated costs of raw materials for many companies while commodity (base metal, steel, batteries and others) inflation, high labor costs and freight charges have added to the woes. In the last year, the industry’s cost of sales escalated 10.2% year over year.

Zacks Industry Rank Indicates Bleak Prospects

The Manufacturing-Tools & Related Products industry is a five-stock group within the broader Zacks Industrial Products sector. The industry currently carries a Zacks Industry Rank #202, which places it at the bottom 21% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak prospects in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of cloudy earnings prospects for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current year moved roughly 7.1% down.

Before we discuss about a few stocks in the industry, we take a look at the industry’s shareholder returns and current valuation.

Industry Underperforms Sector & S&P 500

The Zacks Manufacturing-Tools & Related Products industry has underperformed its own sector and the S&P 500 over the past year.

The stocks in this industry have collectively declined 4.9% compared with 2.3% fall recorded by the Zacks Industrial Products sector and 9.1% gain recorded by the S&P 500.

                                         One-Year Price Performance

Manufacturing-Tools & Related Products Industry’s Valuation

EV/EBITDA ratio is commonly used for valuing manufacturing tools and related products stocks.

The industry’s forward 12-month EV/EBITDA ratio is 8.34. This clearly shows that the industry is trading below the S&P 500’s forward 12-month EV/EBITDA ratio of 12.01 and the sector’s 13.97.

Over the past five years, the industry has traded at the highest level of 11.02x forward 12-month EV/EBITDA ratio and lowest level of 7.15x. The median level, over the same period, was 8.73x.

      Industry’s EV/EBITDA Ratio (Forward 12-Month) Versus S&P 500

         Industry’s EV/EBITDA Ratio (Forward 12-Month) Versus Sector

Bottom Line

Though technological advancements in manufacturing processes across various industries will keep demand healthy for advanced manufacturing equipment, the prevalent headwinds — tariffs, commodity inflation, forex woes, and high labor and freight charges — will pose serious threats to corporate margins and profitability.

Considering the magnitude of the adverse impacts from prevalent hurdles, we believe that the industry might not be able to tide over such issues in the near term. Nonetheless, investors might prefer buying or holding some stocks in their portfolio that have delivered impressive results in the past quarters.

Actuant Corporation (ATU): The stock of this Menomonee Falls, WI-based company has gained 2.2% over the past six months. The stock currently carries a Zacks Rank #2 (Buy). (You can see the complete list of today’s Zacks #1 Rank stocks here.)

The company delivered positive earnings surprise in the last four quarters, with the average being 11.01%. This average includes the impact of 11.76% earnings beat recorded in the last reported quarter. Also, earnings estimates on the stock have improved 0.9% for 2019 and 2.2% for 2020 in the past 60 days.






                                     Price and Earnings Surprise: ATU

Kennametal Inc. (KMT): The stock of this Latrobe, PA-based tool maker has gained 4.9% over the past six months. The stock currently carries a Zacks Rank #3 (Hold).

The company delivered better-than-expected results in three of the last four quarters and lagged the estimate in one. The average earnings surprise for the last four quarters is a positive 3.15%. This average includes the impact of 2.90% earnings beat recorded in the last reported quarter.

Also, earnings estimates on the stock remained stable in the past 60 days, and represented year-over-year growth of 18.1% for fiscal 2019 (ending June 2019) and 11.4% for fiscal 2020 (ending June 2020).

                                     Price and Earnings Surprise: KMT

Lincoln Electric Holdings, Inc. (LECO): This stock of this Cleveland, OH-based company has increased 2.3% over the past six months.

This Zacks Rank #3 stock delivered better-than-expected results in two of the last four quarters while lagged estimate in one and posted in-line results in another. Average earnings surprise for the last four quarters was a positive 2.14%. This average includes the impact of 7.50% earnings beat recorded in the quarter reported last.

                                    Price and Earnings Surprise: LECO

On the flip side, there is one stock in the industry that can be avoided by investors at the moment.

Stanley Black & Decker, Inc. (SWK): This stock of this New Britain, CT-based company has increased 18.7% over the past six months. The stock currently carries a Zacks Rank #4 (Sell).

The company’s earnings were in line with estimates in the last reported quarter. Also, its earnings estimates have declined 0.4% for 2019 and 0.7% for 2020 in the past 60 days.

                                       Price and Earnings Surprise: SWK

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