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Manufacturing Tools & Related Products Outlook: Future Solid

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Accelerating growth in the global economy should boost the advanced and emerging nations, with the U.S. economy likely to be one of the prime beneficiaries. An expanding global and domestic economy is likely to keep demand strong for the companies that manufacture industrial tools.

On the domestic front, improving job market — with unemployment rate of 4% in July compared with 4.3% a year ago — strengthening housing market and the government’s infrastructural development plans will benefit tools manufacturers. Also, policy changes in the past few quarters — the most impressive being the Tax Cut and Jobs Act (enacted in December 2017) — worked wonders.

Underpinning the healthy operating environment for the industrial tool makers are steady growth in the country’s industrial production (from 2.8% in January to 3.5% in May), rise in new orders for the U.S.-manufactured machinery (6.8% year-over-year growth for year-to-month ended May 2018) and improving ISM Purchasing Managers’ Index — suggesting expanding economic activities in the manufacturing sector.

On the other hand, heightened trade tiffs between the United States and some foreign nations, especially China, has left the industrial tool makers dealing with higher costs of raw materials. Though a deterrent, this issue can be easily dealt with.

Industry Performance vs. S&P 500

Looking at shareholder returns over the past two years, it appears that the industry has broadly followed the same pattern as that of the sector and the S&P 500. Strengthening economic conditions slowly boosted investor confidence in the industry’s growth prospects over the past two years. Backed by this and tax policy changes, the industry reached a peak in the initial part of first-quarter 2018.

The Zacks Manufacturing-Tools & Related Products industry, which is a five-stock group within the broader Zacks Industrial Products sector, has outperformed its own sector over the past two years. While the stocks in this industry have collectively gained 24.1%, the Zacks Industrial Products sector has rallied 21.2%.

Also, the industry’s performance was bit behind the Zacks S&P 500 composite’s return of 30% during the period. Impact of higher raw material costs and escalation of U.S.-China trade war can be accounted for the shortfall in the industry’s performance. However, given the positive trend in earnings estimates revisions for the industry (as discussed below), it seems the industry is well positioned to deal with these issues.

Two-Year Price Performance

Manufacturing-Tools and Related Stocks Trading Cheap

Despite the industry’s outperformance in the past two years, the valuation looks really cheap now. One might get a good sense of the industry’s relative valuation by looking at its enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio.

This metric is the most appropriate multiple for valuing manufacturing industries as the enterprise value not only accounts for equity and preference shares, but also takes into account the debts. Also, EBITDA excludes the impact of non-cash expenses.

The industry currently has a trailing 12-month EV/EBITDA ratio of 10.04, which is near the lowest level of 9.63 over the past two years. When compared with the highest level of 12.90 and median level of 10.89 over that period, there is apparently plenty of upside left.

The industry also looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.69 and the median level is 10.91.

                                                  EV-to-EBITDA Ratio (TTM)

Also, a comparison of the group’s EV/EBITDA ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Industrial Products sector’s trailing 12-month EV/EBITDA ratio of 13.93 and the median level of 15.64 for the same period are way above the Zacks Manufacturing- Tools and Related Products industry’s respective ratios.

                                                 EV-to-EBITDA Ratio (TTM)

Solid Earnings Outlook Underpins Continued Outperformance

Technological advancements in manufacturing processes across various industries will keep demand strong for advanced manufacturing equipment. This along with healthy growth potential of the global and domestic economies should drive manufacturing tools makers’ top line, going forward.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants might be interested in gaining exposure in the stock at current levels, backed by its solid near-term potential.

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 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-Tools & Related Products 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 $5.27 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Manufacturing-Tools and Related Products 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 $5.27 'per share' of the industry for 2018, but how this dollar number has evolved recently.

                                      Current Year EPS Estimate Revisions

As you can see here, the $5.27 'EPS' estimate for 2018 is up from $5.20 at the end of January 2018 and $4.95 at the end of July last year. In other words, the sell-side analysts covering the companies in the Zacks Manufacturing-Tools and Related Products industry have been steadily raising their estimates.

Zacks Industry Rank Indicates Solid 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 term.

The Zacks Manufacturing-Tools & Related Products industry currently carries a Zacks Industry Rank #111, which places it at the top 43% 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 the industry’s rank has remained in the top half of the rank list in the past eight weeks.

Manufacturing-Tools & Related Products Industry Promises Long-Term Growth

The long-term (3-5) EPS growth estimates for the Zacks Manufacturing-Tools & Related Products industry appear attractive.

The group’s mean estimate of long-term EPS growth rate reached 9.86% in February 2018. Thereafter, a sharp decline in March and decent recovery in April and May has pegged the growth rate at 10.33% currently. It’s worth noting here that the group’s mean estimate of long-term EPS growth rate is above 9.8% growth rate for the broader Zacks S&P 500 composite.    

                       Mean Estimate of Long-Term EPS Growth Rate

The basis of the industry’s long-term EPS growth could be the sharp increase in top line that the tool makers have been showing since the beginning of 2017.

Bottom Line

Manufacturing-Tools & Related Products industry seems poised to deliver solid returns in the near term. Though prevalent headwinds might create problems, the industry seems well-equipped to handle such hurdles.

Strong near-term prospects, a healthy long-term outlook and cheap valuation make this industry a lucrative option for investors seeking exposure in the U.S. industrial products manufacturing space. Investing in companies with solid earnings prospects and avoiding those with weakening earnings prospects can be nice investment strategy.

Stock to Bet on

Actuant Corporation (ATU - Free Report) : The stock of this Menomonee Falls, WI-based company has gained 15.2% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 2.9% upward over the past 60 days. The stock currently sports a Zacks Rank #1 (Strong Buy). (You can see the complete list of today’s Zacks #1 Rank stocks here.)

                                                       Price and Consensus: ATU

Stocks to Be Cautious Of

Kennametal Inc. (KMT - Free Report) : The stock of this Latrobe, PA-based tool maker has lost 5.3% over the past year. The Zacks Consensus Estimate for the current fiscal year’s (ending June 2019) EPS has been revised 0.3% downward over the past 60 days. The stock currently carries a Zacks Rank #4 (Sell).

                                               Price and Consensus: KMT

Lincoln Electric Holdings, Inc. (LECO - Free Report) : This stock of this Cleveland, OH-based company has declined 3.2% over the past year. The Zacks Consensus Estimate for current-year EPS has been revised 0.2% downward over the past 60 days. The stock currently carries a Zacks Rank #4 (Sell).

                                                  Price and Consensus: LECO

Stanley Black & Decker, Inc. (SWK - Free Report) : This stock of this New Britain, CT-based company has declined 7.6% over the past year. The Zacks Consensus Estimate for current-year EPS has been revised 0.1% downward over the past 60 days. The stock currently carries a Zacks Rank #3 (Hold).

                                           Price and Consensus: SWK

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