After the end of earnings season for the first quarter, the market has been looking for investing themes in the machinery sector. In this context, the Street is bullish on companies with high exposure in end markets involving energy, construction and/or trucks. Let’s have a look at some of them and judge whether these companies deserve a buy rating.
A mixed outlook on this company
Order activity in Caterpillar Inc. (NYSE:CAT)’s resource industries segment remains sluggish and has probably not accelerated according to the company’s prior expectations. This could pressure prior full-year guidance for sales of $60 billion to $68 billion and EPS of $7.00 to $9.00. Given that near-term headwinds in the resource industries division could be greater than what the company previously expected, Caterpillar Inc. (NYSE:CAT) lowered its full-year EPS guidance to reflect a midpoint closer to the current 2013 EPS consensus estimate of $7.25.
Beyond Caterpillar Inc. (NYSE:CAT)’s resource industries segment, trends in its other businesses could be relatively more stable. In particular, the construction industries segment may have some remaining inventory correction in the near term (although the majority of inventory issues in construction were taken care of in 2012) and faces difficult year-ago comparisons from a very strong 2Q 2012, but global construction end markets seem poised to continue a gradual recovery.
North American construction markets remain positioned to continue to recover from recession-era lows and the market has been encouraged by some positive signs in Brazilian construction markets. In addition, Chinese construction-equipment demand, while mixed early in 2013, seems to be in a bottoming phase (Caterpillar Inc. (NYSE:CAT)’s March excavator sales in China were in fact up after an extended period of declines.)
Finally, Caterpillar Inc. (NYSE:CAT)’s power systems businesses could hold up relatively well in 2013, supported by still solid demand for the company’s solar turbines, cost reductions in its locomotive business and at least a stable U.S. power-generation market.
Why this company reiterated its 2013 guidance
The expectations for Cummins Inc. (NYSE:CMI)’ 2013 earnings are relatively muted, reflecting well known lingering headwinds in many of the company’s end markets and strong year-ago results. It is interesting to note that, while Cummins Inc. (NYSE:CMI) has guided to full-year 2013 revenue of flat to down 5%, management has also said that 2013 first-half revenue could be down as much as 10%
Cummins Inc. (NYSE:CMI) remained fairly cautious in its outlook for significant near-term improvements in its businesses. However, a bright spot was that the company discussed a bottoming process in key end markets such as China construction and power gen (though not yet with visibility to meaningful improvement in the near term.)
Talking about other areas in the world, the Brazilian truck markets remain poised to improve through 2013 as economic incentives positively impact truck demand and as year-ago comparisons get easier through the year. In the recent conference call, the management’s commentary on North American truck markets was more constructive. Though Class 8 production rates ran at ~31% below year- ago levels in January and February, recent order trends have been fairly stable and could reflect a gradually improving end market.
In addition, while Cummins Inc. (NYSE:CMI)’ renewed North America supplier relationship with Navistar International Corp (NYSE:NAV) had minimal impact in 1Q 2013, the company highlighted a continued expectation of U.S. heavy duty market share growth in 2013 (likely led by increased Navistar International Corp (NYSE:NAV)-related business), which should, over time, help to grow Cummins’ heavy-duty truck engine revenue and earnings.
Hence, Cummins Inc. (NYSE:CMI) left its current full-year guidance relatively unchanged, as management does not yet have the solid visibility to meaningful end-market improvements that it would likely want to see before raising expectations going forward, nor do I see material end-market degradation that would cause Cummins to lower guidance.
A pure-play on construction activity
The operating margin performance in the crane segment in 1Q 2013 proved to be an important gauge of Manitowoc Company, Inc. (NYSE:MTW)’s ability to meet investor expectations of significant improvement in crane operating margins over the course of 2013; the company managed to post a segment margin of 5.7%, which was higher than 1Q 2012’s 4.4%. This means that the company can benefit from improved operational efficiencies in the segment. However, one should not forget that the comparison is particularly easy as a portion of Manitowoc Company, Inc. (NYSE:MTW)’s crane workforce was on strike in January 2012.
Crane orders and management commentary relative to visibility in the crane segment were also solid, which gave investors another reason to be bullish on the company’s future performance. With 4Q 2012 crane orders of $544 million not having demonstrated the seasonal strength usually expected in 4Q, a return to some seasonal strength in 1Q orders was expected. Crane orders came in at $569 million in the quarter.
That said, quarter-to-quarter crane orders can often be choppy, and even if orders are slower to develop, the improving crawler-crane demand is encouraging. A recent commentary by Essex crane (one of the largest crane-rental companies in North America) is viewed as supportive of improving demand for Manitowoc Company, Inc. (NYSE:MTW)’s higher margin crawler cranes over time, with the company noting continued gradual improvement in utilization rates of its crawler cranes, some apparent strengthening in its power and petrochemical end-markets, and an increase in quotes related to larger transportation infrastructure projects.
Final word
Commentaries from different machinery companies suggest that energy, truck and construction end markets are definitely improving. On these bases, I suggest a buy rating on Manitowoc Company, Inc. (NYSE:MTW) for its high exposure to the crane market and Cummins Inc. (NYSE:CMI) for its high exposure to the truck market. However, I remain neutral on Caterpillar Inc. (NYSE:CAT) despite its heavy exposure to the energy and construction markets. The neutral rating is predicated on the sluggish resource industries segment that accounts for almost one-third of the company’s revenue.
Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article 3 Investing Themes in the Machinery Sector originally appeared on Fool.com is written by Zain Abbas.
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