Per the Institute for Supply Management’s latest report, Purchasing Managers’ Index (PMI) for April was at 52.8%. Although it has declined from the March reading of 55.3%, the manufacturing sector has been witnessing growth for 32 consecutive months, led by continued expansion in new orders, production activity and employment. The PMI has averaged 57.2% over the last 12 months. Notably, a reading above 50% indicates expansion in manufacturing sector. This instils optimism in the sector.
However, the implementation of tariffs on steel imports into the United States last year dealt a severe blow to the manufacturing stocks. Given that steel is a primary raw material, every company involved in manufacturing bore the brunt of rising steel prices owing to tariffs. Though this can be mitigated to some extent with price increases, it might not always be feasible to pass on the price increase to customers. The Trump administration announced that it will impose a 5% tariff on all imported goods from Mexico beginning June 10. Trump plans to gradually increase that tax to 25% until the flow of undocumented immigrants across the border stops. This new concern regarding a U.S. trade dispute with Mexico along with the ongoing U.S. trade war with China have traders and investors on tenterhooks.
Further, the industry has been plagued with shortage of skilled laborers, higher wage costs and flaring-up transportation expenses for quite some time now. Given these concerns, the Industrial Products sector (one of the 16 broad Zacks sectors) has declined 9% compared with the S&P 500 dropped 0.9% over a year’s time.
Despite this underperformance, earnings for the Industrial Products Sector, one of the 16 broad Zacks sectors, rose 1.2% in the first quarter of 2019. Per the latest Earnings Trends report, the sector is expected to register a decline of 1.3% in earnings in the second quarter of 2019. However, the decline is not limited to this sector alone. In the June-end quarter, nine of the 16 Zacks Sectors are expected to witness drop in earnings. In fact, the Industrial Sector’s decline is anticipated to be the least among all. The scenario is likely to improve in the back half of the year, with projected growth of 3.4% in earnings for the third quarter, followed by rise of 10.3% in the fourth quarter.
The sector has an estimated long-term earnings growth of 10.4%, higher than the S&P 500’s 9.5%. This instils optimism in the sector. Continued improvement in residential and non-residential construction, and revival in infrastructure demand bode well for the industry. Mining companies are also resuming capital spending on the back of rising commodity prices. Notably, oil and gas extraction is driving improvement in the mining sector. Further, the recently passed tax reform is likely to act as a catalyst by expediting manufacturing investment in factories, new equipment and other capital goods.
Caterpillar, Inc. (CAT - Free Report) and Deere & Company (DE - Free Report) are two heavyweights hogging the limelight in the sector with market capitalization of $69.7 billion and $45.1 billion, respectively. While Caterpillar is the world's largest manufacturer of construction and mining equipment and also dabbles in agricultural equipment, Deere is the one of the world's foremost producers of agricultural equipment as well as a leading manufacturer of construction, forestry, and commercial and consumer equipment.
Both the stocks carry a Zacks Rank #3 (Hold) currently and a VGM Score of B. Our research shows that stocks with a VGM Score of A or B, combined with a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold), offer the best investment opportunities for investors. You can see the complete list of today’s Zacks #1 Rank stocks here.
Investors keen on this sector is likely to be inquisitive about which one has the more attractive prospects. Let's analyze both these stocks on some key metrics and see which deserves to be part of your portfolio.
Caterpillar’s stock has declined 19.4% in the past year while Deere’s shares have dropped 8.3%. The Industrial Products sector has gone down 9% over the past year while the S&P 500 dipped 0.9%. Deere has fared better in this regard.
The EV/EBITDA metric is usually used to compare two stocks within the same industry or sector and has an edge over other metrics such as P/E because it is not affected by the different capital structures of the two companies. Compared with sector’s EV/EBITDA ratio of 13.1, Caterpillar and Deere are both cheaper propositions with respective reading of 8.0 and 11.2. Caterpillar is cheaper in terms of valuation.
Long-Term Growth Expectations
In terms of long-term earnings growth expectations, Caterpillar scores above Deere with a projection of 12.0% compared with the latter’s 7.9%.
For income investors, Caterpillar has a higher dividend yield (2.80%) than Deere (2.19%). Both have better dividend yields compared with the overall sector’s 1.99%. Caterpillar wins this round.
Inventory Turnover Ratio
Inventory turnover ratio evaluates the efficiency of an industrial company’s manufacturing process. A high inventory turnover ratio ensures that the company is able to manage inventory effectively to generate revenues and avoid wastage.
This is one of the most important financial ratios, which is widely used by industrial companies to measure its ability to utilize inventories. In the last year, the inventory turnover ratio for Deere and Caterpillar has been 3.97% and 3.19%, respectively, lower than the sector’s level of 4.42%. However, Deere has registered better inventory turnover than Caterpillar.
Return on Assets
Return on assets (ROA) is one of the key financial ratios for industrials as they rely heavily on inventory to create revenues. An above-average ROA denotes that the company in question is generating earnings by effectively managing assets. Coming to Caterpillar and Deere, ROA for the trailing 12-months (TTM) is 8.7% and 4.6%, respectively. The Industrial Products sector’s ROA stands at 6.5%.Caterpillar leads on this front compared with Deere.
Earnings Surprise History
Caterpillar has delivered positive surprises in three of the prior four quarters, while Deere missed in all of them. Caterpillar has an average positive earnings surprise of 0.45% while Deere has a negative earnings surprise of 0.45%.
Over the past 60 days, for Caterpillar, the Zacks Consensus Estimate for fiscal 2019 has moved up 0.4% to $12.25 while the estimate for fiscal 2019 for Deere has gone down 8.5% to $10.27.
The Zacks Consensus Estimate for Caterpillar for the fiscal 2019 is currently pegged at $12.25, indicating an improvement of 9% from the year-ago quarter. The earnings estimate for Deere for the current fiscal is pegged at $10.27, suggesting growth of 9% from the year-ago reported figure.
Improvement in construction sector and cost cutting efforts will drive margins for both the companies. Though Deere’s results will continue to bear the brunt of continued weakness in agriculture sector owing to lower farm income, the recently announced $16 billion aid program for American farmers impacted by the trade war will provide some respite. Replacement demand also continues to sustain Deere’s order activity driven by the pressing need to replace older fleet. Both the companies will be hit hard by the escalating tariff war.
Our comparative analysis shows that Caterpillar holds an edge over Deere when considering share valuation, ROA, dividend yield, earnings surprise history, estimate revisions and long-term growth expectations. Deere only scores on inventory turnover and price performance.
On comparison, Caterpillar is clearly a better stock as of now.
Some Other Stocks
Apart from Caterpillar, investors interested in the industrial products sector may also consider DMC Global Inc. (BOOM - Free Report) , Lawson Products, Inc. (LAWS - Free Report) , each sporting a Zacks Rank #1 (Strong Buy), at present.
DMC Global has an estimated earnings growth rate of 83.5% for the ongoing year. The company’s shares have soared 52% in the past year.
Lawson Products has an expected earnings growth rate of 24.5% for the current year. The stock has appreciated 58% in a year’s time.
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