Is It Time To Buy Industrial Stocks?

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Is It Time To Buy Industrial Stocks? by Charles Mann, Columbia Threadneedle Investments

  • We expect industrial stocks to continue to be priced at a discount to the broader market, after trading at a premium during the two prior business cycles.
  • Although a rebound in 2016 is possible, a marked pickup is unlikely due to lower spending on capital equipment and weaker pricing.
  • Slower profit and cash flow growth, weaker business metrics, and an extended business cycle will pressure valuation for most industrials.

The steep decline in oil prices decimated sales and profit as the shale boom has increased energy exposure to record levels. Plus, the strong U.S. dollar and slower global growth weakened overseas demand for U.S. goods. As a result, industrials are priced at a discount to the broader market, after trading at a premium during the two prior business cycles.

  • Inventories are high. Weaker sales growth suggests that destocking will limit industrial production. For example, inventory-to-sales for industrial distributors has reached a multi-year high, and days of inventory at U.S. multi-industrials are at the highest level in over a decade.
  • Utilization is declining. Capacity utilization has weakened in the United States and remains well below prior cycle peaks. While Europe has improved modestly, utilization in China has dropped from 95% to 55% over the last four years.
  • Pricing is weaker. With lower utilization and greater supply, pricing has softened across most industries. With utilization in the United States at 78% below the 81% level generally needed for PPI inflation – stronger price increases are unlikely.
  • Companies are negative. Preliminary guidance from industrial bellwethers such as Cummins, Caterpillar, and Emerson Electric has disappointed, as sales will shrink for a second year. But many hope that the 2015 carnage will create a favorable setup for sales and earnings growth in late 2016.

Although a rebound in 2016 is possible, a marked pickup is unlikely due to lower spending on capital equipment and weaker pricing, which will lead to slower profit and cash flow growth. Further, weaker business metrics and an extended business cycle will pressure valuation for most industrials, and the discount to the broader market will persist.

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