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Industrial Manufacturing Stock Outlook: Space Gathering Steam

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The Institute for Supply Management (ISM) manufacturing index jumped to 58.7% in May from 57.3% recorded in the prior month, indicating that manufacturing activity accelerated in despite the prevailing uncertainty over trade policy.

Corporate spending across manufacturing industries is shoring up at a healthy pace on the back of the December-enacted tax overhaul, increased government spending and rising oil prices.

However, the benefit of lower corporate taxes has not yet fully materialized. Going forward, tax cuts will likely expedite manufacturing investment in factories, new equipment and other capital goods.

This article discusses the outlook of machinery manufacturing companies that are engaged in producing various types of industrial equipment tools. The U.S. industrial production improved 3.5% annually in May, per the latest Fed report. The upswing highlights that demand for industrial equipment has been spurring, of late.

Hence, listed industrial manufacturing stocks will likely gain from a booming American economy.

Industry Returns Outpace Sector’s Yield

The Zacks Manufacturing - General Industrial Industry, which is a 39-stock group within the broader Zacks Industrial Products Sector, has underperformed the S&P 500 group but outpaced its sector over the past year.

While the stocks in this industry have collectively gained 4.8%, the Zacks S&P 500 Composite and Zacks Industrial Products Sector have gained 13.3% and 2%, respectively (the blue line in the chart below represents the industry). 

One-Year Price Performance

As you can see, the industry's stock market performance peaked in late January, as did the broader market. But it has failed to get back to those levels ever since, most likely reflecting the industry's exposure to international trade. Other headwinds like workforce shortage, surging transportation costs and inflation in the prices of some major inputs are likely also at play in the group's recent weakness, but it's safe to pin the blame squarely on trade uncertainty.  

Group Trading Cheaper Than Sector

One might get a good sense of the industry’s relative valuation by looking at its enterprise value-to EBITDA ratio (EV/EBITDA), which is the most appropriate multiple for valuing industrial manufacturing stocks.

The Manufacturing - General Industrial industry is a capital-intensive industry with high fixed costs, the bulk of which is funded through debt. Moreover, these companies have high depreciation expenses due to a large fixed asset base. The EV/EBITDA ratio essentially measures the value of an industrial manufacturing company, inclusive of debt and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.

The industry currently has a trailing 12-month EV/EBITDA ratio of 11.6X, which is below the 12-month median of 12.8X. Over the past year, the industry has traded as high as 13.9X and as low as 11.4X.

The S&P 500 index is also currently trading at 11.6X trailing 12-month EBITDA, with a high, low and median over the past year of 12.7X, 10.7X, and 11.3X, respectively.

Enterprise Value/EBITDA Ratio (TTM)

Despite outperforming the sector over the past year, the industry’s valuation looks cheap now.  Comparing the group’s EV/EBITDA ratio with that of its broader sector shows that the industry is trading at a discount. The Zacks Industrial Products Sector’s trailing 12-month EV/EBITDA ratio of 14.2X is above the Zacks Manufacturing - General Industrial industry’s ratio.

Enterprise Value/EBITDA Ratio (TTM)

The industry's valuation picture is similarly attractive on other metrics, like P/Es. On a forward 12-month P/E basis, the industry is currently trading at 18X, which is down from 22.5X in late-November 2017. On a forward 12-month P/E basis, the industry has traded as high as 22.5X and as low as 15.2X, with a 5-year median of 18.3X. 

Earnings Outlook Looks Positive & Stable

Robust industry fundamentals and expectations of solid top-line growth will likely help the industrial manufacturing stocks generate higher shareholder returns in the near future.

Investors would also be eager to watch whether this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry below shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.


Price and Consensus: Zacks Manufacturing - General Industrial Industry

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $4.74 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Gaming industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $4.74 'per share' of the industry for 2018, but how this dollar number has evolved recently.  

Current Fiscal Year EPS Estimate Revisions

As you can see here, the $4.74 'EPS' estimate for 2018 is down from $4.82 at the end of April and $4.76 at the end of the month period to that, but up materially from estimates at year-end 2017 and in June 2017. In other words, the sell-side analysts covering the companies in the Zacks Manufacturing - General Industrial industry have modestly cut estimates recently. But estimates have gone up significantly from 6 and 12 months back. 

For more details about Zacks aggregates and other analytics, please check the Zacks Research System home page. 

Zacks Industry Rank Indicates Bullish Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near future.

The Zacks Manufacturing-General Industrial industry currently carries a Zacks Industry Rank #40, which places it at the top 16% of more than 250 Zacks industries. 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.

Our proprietary Heat Map shows that this industry’s rank was in the top 50% for the past eight weeks.

Industry Heat Map

Industry Assures Long-Term Growth

The Zacks Manufacturing-General Industrial industry has promising long-term prospects. The group’s mean estimate of long-term (3-5 years) EPS growth rate has been rising since mid of January 2018 to reach the current level of 12.3%. This compares favorably to 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

In fact, the basis of this long-term EPS growth could be the recovery in top line that the Zacks Manufacturing-General Industrial industry has been showing since the beginning of 2017.

Zacks Manufacturing-General Industrial Industry Revenues

Another important indication of the industry’s solid long-term prospect is improvement in the return on capital employed (ROIC). The image below clearly shows that the group’s ROIC has been improving since 2017.

Zacks Manufacturing - General Industrial Industry ROIC

Bottom Line

The Purchasing Managers Index in the United States has remained above 50 since the beginning of 2018, undoubtedly verifying that the space remains in very good health. The industry is also adding to its payrolls at a healthy pace, with the year-to-date gains coming in at 259,000. An upswing in production and new order numbers in May’s ISM report reveals that the sector is currently gathering steam and is unlikely to cease hiring in the near future.

This outlook analysis proves that industrial manufacturing companies will likely keep their earnings streak alive in the upcoming quarters. The group not only underlines a stable and bullish bottom-line outlook, but has also been trading at a discount, of late.

This all-around positive outlook notwithstanding, the trade issue remains a big headwind for the group, as it is for many other export-oriented industries. This trade worry notwithstanding, we have picked four stocks here that are worth looking into. 

These picks carry a Zacks Rank #1 (Strong Buy) or 2 (Buy), and have witnessed positive earnings estimate revisions for the last 60 days.  

Twin Disc, Incorporated (TWIN - Free Report) designs, manufactures and sells heavy duty off-highway and marine power transmission equipment across the globe. The Zacks Consensus Estimate for earnings has surged 104.5% to 90 cents for fiscal 2018 (ending June 2018). The company currently sports a Zacks Rank of 1.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Kadant Inc. (KAI - Free Report) supplies critical components and equipment used in paper recycling, papermaking, waste management and other process industries globally. The company holds a Zacks Rank #2, at present. The Zacks Consensus Estimate for 2018 earnings has moved up 3.8% to $5.20.

Roper Technologies, Inc. (ROP - Free Report) develops, designs engineered and software products, and solutions. The company also carries a Zacks Rank of 2. The Zacks Consensus Estimate for the current-year earnings has inched up 0.9% to $11.25.

Luxfer Holdings PLC (LXFR - Free Report) designs, manufactures and sells high-performance components, materials, as well as high-pressure gas-containment devices. The Zacks Consensus Estimate for this Zacks #2 Ranked company’s earnings has moved 10.3% north to $1.29 for 2018.

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