The Zacks Industrial Products sector’s fourth-quarter 2022 performance is likely to have been driven by strength in demand across several end markets. However, persistent supply chain constraints and labor and logistics challenges might have impaired players’ ability to meet the high demand levels. Signs of easing supply-chain issues through the quarter instill hope. While inflationary cost pressure, primarily stemming from raw material, energy and freight, is likely to have dented margins, cost control measures and pricing actions exercised by sector participants are expected to have negated these impacts on their margins.

Around 4% of the companies within the Industrial Products sector have reported fourth-quarter earnings numbers so far, with a 100% beat on both earnings and revenues. Earnings increased 9.8% year over year on 13.2% higher revenues. It is too soon to draw a conclusion with the major chunk of companies yet to report. Of these, Caterpillar Inc. (CAT Quick QuoteCAT - Free Report) , Deere & Company (DE Quick QuoteDE - Free Report) , Illinois Tool Works (ITW Quick QuoteITW - Free Report) , Parker–Hannifin (PH Quick QuotePH - Free Report) and Xylem Inc. (XYL Quick QuoteXYL - Free Report) are some of the prominent players, which are poised to deliver an earnings beat this season.

Expectations For the Sector for Q4

Per the latest Earnings Trends report, the Industrial Sector is likely to deliver 11.6% growth in earnings for the fourth quarter of 2022 on the back of an 8.4% sales increase. The projected growth reflects a deceleration from a 20.5% rise in earnings on a 14.5% increase in revenues in the third quarter. Nevertheless, the sector is one of the eight sectors that are expected to post growth this earnings season. This is commendable, considering the inflationary scenario and the supply chain snarls.

Factors at Play During the Quarter

Per the Federal Reserve, industrial production decreased 0.2% in November 2022. Manufacturing output dipped 0.6% for the month but remained 1.2% above last year. Overall, industrial production gained 2.5% over the 12-month period that ended November 2022. In December, the Institute for Supply Management’s (ISM) manufacturing index touched 48.9%, contracting for the second month in a row. The average for the past 12 months (ended December 2022), however, stood at 53.5%. Amid the ongoing uncertainty in the global economy and persisting inflationary trends, some customers have been curbing spending.

The manufacturing sector had been bearing the brunt of the supply-chain issues. Some of the industry players recently noted that the supply-chain situation is gradually improving. The delivery performance of suppliers to manufacturing organizations was reported to be faster for the third straight month in December.

Strength across end-markets such as agriculture, construction, mining, transportation, gas utilities and energy transition is likely to have aided the performances of the industrial companies in the December ended quarter. Stable packaging demand for food, beverages and medicines and rise in e-commerce activities are likely to have aided the performance of companies engaged in the production of packaging materials. Solid backlog levels, cost-control measures, effective pricing and operational execution are expected to have favored performance in the to-be-reported quarter.

How to Pick Winners?

Given the large number of players operating in the industrial products space, picking the right stocks is not an easy task. But our proven model makes it fairly simple. One can shortlist with the combination of a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold), which increases the odds of an earnings beat. You can see the complete list of today’s Zacks #1 Rank stocks here.

You can uncover the best stocks to buy or sell before they report earnings with our Earnings ESP Filter.

Earnings ESP — the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate — is our proprietary methodology for determining the stocks with maximum chances of delivering positive earnings surprises in their next announcements. Our research shows that for stocks with this perfect combination, the chances of a beat are as high as 70%.

Our Choices

Below we list five industrial stocks that have the right mix of elements to pull off positive surprises this earnings season.

Caterpillar has an Earnings ESP of +1.14% and a Zacks Rank #3. CAT is slated to release fourth-quarter 2022 earnings numbers on Jan 31, before market open. The company beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters, the average surprise being 14.7%.

Caterpillar’s results are the most watched in the sector as it is considered a bellwether for the global economy. The world's largest manufacturer of heavy industrial equipment has delivered year-over-year improvement in revenues and earnings for seven straight quarters, thanks to its cost-saving actions, strong end-market demand and pricing actions that offset the impact of supply chain issues and cost pressure. Its fourth-quarter results are likely to reflect these factors as well. Also, the company ended the third quarter of 2022 with an impressive backlog of $30 billion, which is also likely to have boosted the fourth quarter top-line. The fourth quarter of the year is historically the strongest quarter for CAT in terms of sales due to seasonal factors.

Deere has an Earnings ESP of +2.83% and a Zacks Rank #2. It is slated to release first-quarter fiscal 2023 results on Feb 17, before market open. The company has a four-quarter trailing average earnings surprise of 7%.

Deere’s results are likely to reflect the favorable farm fundamentals. Improved commodity prices and the consequent improvement in farm income are likely to have made farmers spend more on agricultural equipment. This is likely to have translated into improved order levels for Deere. Strong replacement demand is also expected to have boosted its top line. While supply-chain issues, high production costs, are likely to have impacted the company’s margin in the quarter, favorable price realization and higher shipment volumes/sales mix are expected to have negated some of these headwinds.

Illinois Tool Works has an Earnings ESP of +2.24% and a Zacks Rank #3. ITW is scheduled to release fourth-quarter 2022 earnings on Feb 2. The company has a four-quarter trailing average earnings surprise of 4.2%.

Illinois Tool’s results for the quarter under review are likely to reflect strong demand in semiconductor businesses, equipment as well as consumables manufacturing operations. Continued strength in industrial applications, construction, U.S. residential and commercial end-markets bode well for the fourth-quarter results. Contributions from recent acquisitions are also likely to have supported results. While supply chain disruptions and raw material cost inflation remained headwinds, pricing actions are expected to have offset some of the impact on margins.

Xylem has an Earnings ESP of +1.27% and a Zacks Rank #2. The company is scheduled to release fourth-quarter 2022 earnings on Feb 7. The company has a four-quarter trailing average earnings surprise of 13.3%.

Xylem’s fourth-quarter performance is expected to have been aided by its strong backlog levels and solid demand across its end markets. Due to the essential nature of its business, demand remains robust. Its Water Infrastructure segment is benefiting from effective price realization and robust transport demand in Western Europe.  The Applied Water segment is expected to have gained from strong price realization and backlog execution in industrial, commercial and residential end markets. Measurement & Control Solutions is likely to have benefited from robust demand in the advanced metering infrastructure (AMI) end market and modest improvement in chip supply. Pricing actions to mitigate cost inflation and gradual easing of supply-chain constraints are likely to have benefited its bottom line.

Parker–Hannifin has an Earnings ESP of +0.21% and a Zacks Rank #3. PH is expected to release second-quarter fiscal 2023 earnings on Feb 2. The company has a four-quarter trailing average earnings surprise of 11.3%.

PH’s quarterly performance is likely to have been aided by strong demand across end markets and higher order levels. The company is also expected to have gained from its unique Win Strategy (version 3.0 launched in fiscal 2020), which focuses on innovation, strategic positioning, distribution growth and incentive plan changes to drive organic growth. The Win strategy has been supporting the company’s margin expansion. PH’s effective pricing and supply-chain management actions are also expected to have negated the impact of high costs in the quarter.

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