Shift in production approach from conventional to digitized, largely driven by the growing adoption of Internet of Things across industries and rising labor wages in major manufacturing hubs, have provided an impetus to the process-automation and instrumentation-control market globally. With the recovery of some key end markets and improved macroeconomic climate since last year, the market is expected to thrive in 2018 and beyond.
The United States holds a dominant position in the global industrial controls for process manufacturing. The industry is being driven by continually increasing demand for energy-efficient production processes, safety and security concerns and software systems that anticipate failure at a granular level, resulting in better monitoring and helping in predictive maintenance of the system.
On the other hand, analytical instruments have very little scope for differentiation, and major analytical equipment manufacturers have started following strategies such as forming alliances with other vendors or acquiring competitors to enhance top-line growth. The market is mainly dependent on R&D investments, and since the local vendors lack the huge capital to spend on R&D, they either exit the market or get acquired by well-established vendors.
Industry Outshines on Shareholder Returns
Looking at shareholder returns over the past year, it appears that the continually increasing market demand for energy-efficient production processes, safety and security concerns along with software systems for better monitoring and predictive maintenance of the system were enough to boost investor confidence in the industry’s prospects. Moreover, improving oil and gas industry has been responsible for this unprecedented growth as the industry requires advanced industrial controls for processing and manufacturing final products.
The Zacks Instruments – Control Industry within the broader Zacks Computer and Technology Sector has outperformed the S&P 500, but modestly underperformed its own sector, over the past year.
While the stocks in this industry have collectively gained 15.9% over the past year, the Zacks S&P 500 Composite and Zacks Computer and Technology Sector have rallied 13.6% and 17.9%, respectively.
One-Year Price Performance
It is worth noting that the analytical instrument market in the United States is characterized by the presence of several well-established international vendors. In addition, the market consists of a number of regional and local analytical instrument companies that offer quality equipment with excellent aftersales services. As a result, the market appears to be fragmented and is highly competitive. Vendors have to differentiate their products in order to sustain themselves in the competitive market.
Instruments Control Stocks Trading High
The industry's valuation picture looks moderately expensive. 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 instruments control stocks.
Instruments control is a capital-intensive industry, incurring significantly high capital investments for technologically obsolescent products and high R&D expenses. The firms have high depreciation expenses due to a large fixed asset base. The EV/EBITDA ratio essentially measures the value of a 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 of 11.7X, which is above the 12-month median of 11.1X. Over the past year, the industry has traded as high as 12.2X and as low as 10X.
The S&P 500 Index is also currently trading at 11.7X trailing 12-month EV/EBITDA with a high, low and median over the past year of 12.7X, 10.7X, and 11.4X, respectively.
Enterprise Value/EBITDA Ratio (TTM)
Comparing the group’s EV/EBITDA ratio with that of its broader sector also shows that the group is trading at a premium. The Computer and Technology Sector’s trailing 12-month EV/EBITDA ratio of 11.1 is below the Zacks Instruments Control Industry’s ratio.
Enterprise Value/EBITDA Ratio (TTM)
Outperformance May Continue on Solid Earnings Outlook
The U.S. process automation & instrumentation market is expected to witness a moderate growth rate, attributable to the rising emphasis on regulatory compliance in process industries and increasing demand for proactive solutions that can determine failures at component level. Control valves happen to be the most commonly used control elements in process control systems. These are being devised to enable the flow of a fluid through a pipe based on the commands received from loop. The burgeoning population worldwide is leading to an increase in demand for energy, resulting in the rise of investments in the energy sector. In addition, the rising demand for clean portable water, along with safe and efficient waste collection and waste disposal facilities, is anticipated to augment growth of the market in the coming years.
But what really matters to investors is 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 is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the performance of its stock.
One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with last year’s reported number. However, an effective measure could be the magnitude and direction of the recent change in earnings estimates.
The light blue line in the chart below shows the evolution of aggregate 2018 earnings estimates for operators in this space (the red line represents 2019 expectations). The consensus estimate for the Zacks Instruments Control Industry of $3.06 implies a year-over-year growth of 6.6% as the trend in earnings estimate revisions continues to remain favorable.
Price and Consensus: Zacks Instruments – Control Industry
Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings potential.
The consensus EPS estimate for the current fiscal year has been revised 5.5% upward since the beginning of the year.
Current Fiscal Year EPS Estimate Revisions
Zacks Industry Rank Indicates Optimistic 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 Instruments – Control industry currently carries a Zacks Industry Rank #46, which places it at the top 18% 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 more or less remained favorable over the past six weeks.
Instruments Control Promise Long-Term Growth
While the valuation picture of the group seems to be disagreeable for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Instruments Control Industry appears promising. The group’s mean estimates of long-term EPS growth rate have been raised to reach the current level of 10.9%. This compares to 9.8% for the Zacks S&P 500 Composite.
Mean Estimate of Long-Term EPS Growth Rate
Industry Portrays Improving Revenues and Earnings Trend
The bullish outlook finds solid traction in the sturdy top- and bottom-line performance over the past few years. The instruments control firms have shown modest recovery in the top line since the beginning of 2015.
Another important indication of improving long-term prospects is the uptrend in the group’s GAAP earnings per share, which improved sharply from 2016 onward.
The United States is a major market for factory automation and industrial control within the North American region. The demand for advanced manufacturing robotic technologies will, to some extent, boost growth of the market in the region. The focus on building a high-end cyber-physical system to improve productivity by delivering connected, intelligent manufacturing systems capable of supporting high-levels of customization, flexibility and end-to-end manufacturing process automation will help the market grow.
Growth of the industrial control for process manufacturing in the Americas is a result of ongoing replacement of current industrial control systems with modern ones to bring in advanced processing solutions. The increased competitiveness among vendors and manufacturers is expected to improve growth prospects of industrial automation. Other benefits include an increase in production capacity, minimized energy consumption, lower feedstock variability to downstream units, reduction in process setting time, faster modification of processes, improved process safety and increase in equipment reliability. The growing oil and gas industry of the Americas has also been responsible for this unprecedented growth as the industry requires advanced industrial controls for processing and manufacturing final products.
While none of the stocks in our instruments control universe currently sport a Zacks Rank #1 (Strong Buy), below is one stock that has been witnessing positive earnings estimate revisions and carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Woodward, Inc. (WWD - Free Report) : This Fort Collins, CO-based instruments control firm has gained 14% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 1% upward over the last 90 days.
Price and Consensus: WWD
Investors may also hold on to the following three stocks having a Zacks Rank #3 (Hold).
Transcat, Inc. (TRNS - Free Report) : Shares of this Rochester, NY-based instruments control firm have rallied 77.9% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 2.2% upward over the last 90 days.
Price and Consensus: TRNS
Allied Motion Technologies Inc. (AMOT - Free Report) : This Amherst, NY-based instruments control firm has gained 61.7% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 17.9% upward over the last 90 days.
Price and Consensus: AMOT
Watts Water Technologies, Inc. (WTS - Free Report) : The consensus EPS estimate for this North Andover, MA-based instruments control firm has improved 1.4% for the current fiscal year, over the last 90 days. The stock has returned 28.2% over the past year.
Price and Consensus: WTS
The Hottest Tech Mega-Trend of All
Last year, it generated $8 billion in global revenues. By 2020, it's predicted to blast through the roof to $47 billion. Famed investor Mark Cuban says it will produce "the world's first trillionaires," but that should still leave plenty of money for regular investors who make the right trades early.
See Zacks' 3 Best Stocks to Play This Trend >>