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Near-Term Outlook Bleak for Manufacturing Tools Industry

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Tools and related products manufacturers primarily engage in developing and distributing 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 more related products are also produced by some of the tool makers.

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

Here are the three major themes in the industry:

  • Increasing industrial production, rising use of sophisticated technologies in manufacturing process, growth in investments for infrastructural development, spur in new construction and remodeling activities as well as availability of skilled work force are a few important factors contributing to demand for industrial tool and related products in the United States. It’s worth noting here that industrial production in the United States increased 3.3% year over year in the third quarter of 2018 and expanded 4.1% in October 2018. Moreover, the growing adoption of e-retailing has created new business opportunities for tool makers. Over the last three years (2015-2017), the industry’s revenues witnessed CAGR of 4% and increased 6.9% in the first nine months of 2018.
  • Favorable tax policy changes — like the Tax Cut and Jobs Act enacted in December 2017 — worked wonders for corporates in the United States and industrial companies were no exception. Also, demand for U.S.-made machineries has been strong — evident from 5.7% growth in new orders in the first nine months of 2018. However, the impact of fiscal stimulus on the country’s budget, geopolitical tensions across global counterparts and slowdown in worldwide growth may impact industrial activities and hence influence demand for tools. Also, unfavorable movements of foreign currencies may impede top- and bottom-line growth.
  • Rising trade tension between the United States and foreign countries, especially China — due to the imposition of import tariffs on steel, aluminum and many other items — is concerning. Many industrial companies are currently dealing with commodity (base metal, steel, batteries and others) inflation, tariffs imposed on steel and aluminum under Section 232 and tariffs on certain other items valid under Section 301. We believe that the government’s protectionism policy as well as high labor costs and freight charges is having an adverse impact on corporate margins and profitability. Over the last three years (2015-2017), the industry’s cost of sales witnessed CAGR of 3.3% and increased 8.2% in the first nine months of 2018. Also, the industry’s gross margin (TTM) in the first three quarters of 2018 was down 80 basis points from 2017 level.

Zacks Industry Rank Indicates Near-Term Weakness

The Zacks 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 #184, which places it at the bottom 28% 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 bleak 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.

Our proprietary Heat Map shows that the industry’s rank has remained in the bottom half of the rank list for the majority of the past eight weeks.

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. The industry’s earnings estimates have been revised lower by 2.1% quarter to date while the same has been lowered 2.8% so far in the second half of 2018.

We will present a few stocks that may be considered for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

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 20.3% compared with 11.6% fall recorded by the Zacks Industrial Products sector and 4.2% 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 7.88. This clearly shows that the industry is trading below the S&P 500’s forward 12-month EV/EBITDA ratio of 10.52 and the sector’s 11.90.

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 7.24x. The median level, over the same period, was 8.86x.

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

Bottom Line

Technological advancements in manufacturing processes across various industries will keep demand strong for advanced manufacturing equipment. This along with healthy growing industrial production in the country and rising demand for U.S. made machineries work well for the industry. However, prevalent headwinds — tariff and forex woes as well as high labor and freight charges — create problems.

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.  Investment in the industry might not be an appropriate move at the moment. Nonetheless, investors might prefer holding some stocks in their portfolio that have delivered impressive results in the past quarters.

Below we present four companies carrying Zacks Rank #3 (Hold), which investors may prefer holding at current levels:

Actuant Corporation ATU: The stock of this Menomonee Falls, WI-based company has gained 5.6% over the past month. Average earnings surprise for the last four quarters is a positive 4.55%. This average includes the impact of 11.43% earnings beat recorded in the last quarter. (You can see the complete list of today’s Zacks #1 Rank stocks here.)

                                         Price and EPS Surprise: ATU

Kennametal Inc. (KMT - Free Report) : The stock of this Latrobe, PA-based tool maker has gained 17.5% over the past month. In the last reported quarter, the company’s results were better than expected, with positive earnings surprise of 7.69%. The average earnings surprise for the last four quarters is a positive 1.95%.

                                         Price and EPS Surprise: KMT

Lincoln Electric Holdings, Inc. (LECO - Free Report) : This stock of this Cleveland, OH-based company has increased 6.5% over the past month. The company’s average earnings surprise for the last four quarters is a positive 1.56%.

                                      Price and EPS Surprise: LECO

Sandvik AB (SDVKY - Free Report) : This stock of this Stockholm, Sweden-based company has declined 5.9% over the past month. The company’s average earnings surprise for the last four quarters is a positive 34.52%.

                                    Price and EPS Surprise: SDVKY

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