International Trade On the Rise As Demand For U.S. Made Goods Increases
Zacks Investment Research | Sep 10, 2014 12:53AM ET
Recovery in the global economy has been irregular over the last few years. While the world economy grew 3.5% in 2012, the pace decelerated to 3.2% in 2013 and growth is expected to be only modestly better in 2014 at 3.4% and 4% in 2015, according to the IMF’s July World Economic Outlook.
Advanced economies are projected to climb 1.8% in 2014 and 2.4% in 2015. These growth projections are considered crucial for global expansion as well as for the progress of emerging and developing nations. Emerging economies are predicted to grow by 4.6% in 2014 and 5.2% in 2015.
A chart displaying Gross Domestic Product (GDP) of the global economy as well as that of selected developed nations, including the U.S, Japan and the Eurozone, and emerging countries like China, India, Brazil and South Africa is provided below:
A spur in economic growth inducing more industrial activities is considered favorable for the expansion of the machinery industry. This direct correlation, right on the heels of the expected economic growth worldwide, makes us confident about the machinery industry. Across nations, the level of industrial activities is measured in terms of industrial production -- output of the manufacturing, mining and utilities sectors.
A brief discussion on the prospects of the machinery industry in different nations has been provided below.
Prospects in the United States
The U.S. operating environment for the machinery industry was quite favorable in the second quarter of 2014. Industrial production grew 5.5% year over year, including a 6.7% hike in manufacturing production and an 18.8% increase in mining production. However, utilities suffered a 21.4% decline.
Per the latest report by the Federal Reserve, industrial production in July inched up 0.4% over the previous month and grew 5% year over year. The latest jobs report was surprisingly weak, though it may not be reflective of ground realities as other recent economic data has been indicating. This improving economic backdrop has prompted the Federal Reserve to discontinue its bond purchases by year-end 2014.
Beyond U.S. shores, export demand is a key factor for the U.S. machinery industry. According to the U.S. Census Bureau report published in Sep 2014, machinery shipments increased by 4.9% in the seven months ended Jul 2014. Shipments for industrial and metalworking machinery rose by 33.3% and 7%, respectively; while that for farm machinery was down 12.3% and construction machinery by 2.4%. New machinery orders were up 7.8%, while order backlog grew 12.5%.
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Also, international trade is on the rise. Export demand for U.S-made goods, especially automotive vehicles and parts, consumer articles, industrial supplies and materials, and food and beverages, increased by roughly $2 billion to $198 billion in July.
The world’s largest economy held nearly 16.5% of the global GDP on purchasing power parity (PPP) basis, in 2013. Over the last five years, the country’s GDP growth movement were in sync with its industrial production. With the IMF anticipating the economy to grow by 1.7% in 2014 and 3% in 2015, one can gather a fair idea about the growth prospects of the machinery industry.
Japanese Markets
The latest report by Japan’s Cabinet Office reveals that total machinery order grew 17.1% in Jun 2014 over the previous month, while it increased 14.4% sequentially for three months ended Jun 30, 2014. Private-sector machinery order (excluding volatile orders from ships and electric power companies) or core machinery order were down 10.4% in the quarter, raising concerns over the future of capital investments by companies. Orders from governments and overseas clients increased 30.3% and 42.2% respectively.
For third-quarter 2014, core machinery orders are expected to increase 2.9% sequentially. However, lower orders from governments and overseas clients, coupled with weak demand from private and manufacturing sectors, are likely to pull down total machine orders by 15.3%.
Moreover, the country’s GDP contracted 1.7% in second-quarter 2014 (or 6.8% on an annualized basis) versus 1.6% growth recorded in the previous quarter. Consumption demand was weak due to a 3% increase in sales tax in Apr 2014, compelling the Bank of Japan to lower its real GDP growth forecast to 1.1% for fiscal 2014 (ending Mar 2015), from the earlier expectation of 1.4%. Further cuts by the Central Bank are expected in Oct 2014. The IMF predicts the economy to grow by 1.6% in 2014 and 1.1% in 2015.
Emerging Nations
China: The Chinese government is focused on rapid urbanization and has planned major investments accordingly. Domestic demand is strong in the country while exports are also on the rise. Further, efforts in improving trade relations with Brazil, Russia and other countries are expected to boost growth.
The world’s second largest economy recorded a 6.9% year-over-year increase in its foreign trades in Jul 2014. Exports grew 14.5% while imports declined 1.6%. Industrial production in Jul 2014 increased 9% over the year-ago month.
Growth in 2014 is expected to be driven by investments and a rise in demand from the advanced economies. The IMF anticipates the Chinese economy to grow by 7.4% in 2014 and 7.1% in 2015.
India: The country’s industrial production in Jun 2014 grew 3.4% over the year-ago month backed by 4.3% growth in mining, 1.8% in manufacturing and 15.7% in electricity sectors. GDP in the first-quarter fiscal 2014 (ended Jun 30, 2014) is estimated to grow by 5.7% year over year.
A rise in domestic and external demand, expectation of policy improvements and better monsoon conditions are the primary growth drivers for the country. The newly-formed government has already taken certain measures to successfully boost the country’s foreign capital inflow. According to the IMF, the country is projected to grow 5.4% in 2014 and 6.4% in 2015.
Brazil: The country’s outlook for 2014 is a bit gloomy owing to low private investments and inadequate infrastructure. The IMF has lowered its growth forecast on the country to 1.3%, down 60 bps from its prior estimate. In Jul 2014, the country’s industrial production fell by 3.6% year over year.
However, the country’s long-term prospects shine bright backed by its fast growth as the favorable destination for foreign direct investments. Industries like tourism, steel and electricity among others, are gaining strength and promise robust growth.
Also, the Brazilian government, under its Growth Acceleration Program or PAC – phase II, has planned major investments for the development of ports, railroads, airports, wind farms and roads. Other areas of focus are sanitation, energy and logistics. Further, to promote its export businesses, roughly 24 Free Trade Zones (FTZ) is being set up across 20 Brazilian states.
South Africa: The government is focused on improving its mining, manufacturing chemicals and agricultural sectors. Huge public investments have been announced under the infrastructure development programs. Moreover, the country is keen on expanding its trade relations with its largest exporter-cum-importer country, China. The IMF expects the country to grow by 1.7% in 2014 and 2.7% in 2015.
In Jun 2014, the country’s industrial production edged up 0.5% year over year, while it’s GDP grew by an annualized 0.6%.
Euro-zone
The Euro-zone’s industrial production (excluding construction) in Jun 2014 was down 0.3% over the previous month while being stable year over year, as per Eurostat’s data in Aug 2014.
According to the VDMA Machine Makers’ Association, German machine tool orders in second-quarter 2014 rose by 1% year over year. Domestic orders were up 16% while international orders fell by 7%. GDP remained pegged at the previous quarter’s level.
Zacks Industry Rank
Within the Zacks Industry classification, Machinery is broadly grouped into the Industrial Products sector, one of the 16 broad Zacks sectors.
More than 260 industries are ranked in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry.
As a guideline, industries with Zacks Industry Rank of #88 and lower are considered to have a positive outlook, those between #89 and #176 have a neutral outlook while the ones with #177 and higher possess a negative outlook.
The machinery industry is further sub-divided into five industries at the expanded level: machine tools and related products, machinery – construction and mining, machinery – electrical, machinery – farm and machinery – general industries.
The Zacks Industry Rank for machine tools and related products is #94, machinery – construction and mining is #95, machinery – electrical is #97, machinery - farm is #98 and machinery - general industries is #99. Considering the Zacks Industry Rank of all the machinery related industries, it can be deduced that the sub segments of the machinery industries have a neutral outlook.
Earnings Trends of the Sector
Let's take a look at the sector’s performance in second-quarter 2014. Nearly 96% of the total Industrial Products companies in the S&P 500 group reported their results as of Aug 28. Earnings grew 3% year over year with a beat ratio (percentage of companies coming out with positive surprises) of 54.2%. Revenues declined 1.6% with a beat ratio of just 25%.
With demand in domestic and international markets picking up, improvements are anticipated in the sector. For the industrial sector, earnings growth is predicted at 7.8% in 2014 and 10.3% in 2015, to be driven by margin improvements. Revenue growth is likely to be 4% in 2014 and 3.6% in 2015.
In view of all the Zacks sectors combined, total earnings growth rate is predicted at 8.3% for 2014 and 12% for 2015. Revenue is anticipated to grow by 1.9% in 2014 and 4.2% in 2015.
Important Players in the Machinery Industry Lincoln Electric Holdings Inc (NASDAQ:LECO)
Some other companies worth mentioning in the industry include Actuant Corporation (NYSE:ATU), Stanley Black & Decker Inc (NYSE:SWK) and Kennametal Inc (NYSE:KMT)
Caterpillar Inc (NYSE:CAT): The company operates in the construction and mining machinery industry with a current market capitalization of $68.2 billion. It is one of the leading manufacturers of construction and mining equipment, diesel and natural gas engines and industrial gas turbines. The company is well positioned to benefit from the recovery in the U.S. construction sector. Also, growing export demand in the country will bode well for the company going forward. Over the next five years, earnings are anticipated to grow 10.2%.
Some other important companies in the industry include Astec Industries Inc (NASDAQ:ASTE), Manitowoc Company Inc (NYSE:MTW). and Terex Corporation (NYSE:TEX)
Smith AO Corporation (NYSE:AOS): The company, with a market capitalization of $4.5 billion, operates in the electrical machinery industry. It is one of the leading manufacturers and marketers of residential and commercial water heating equipment as well as one of the largest manufacturers of electric motors in North America.
The company is capitalizing on growing residential replacement water heater and commercial water heater businesses. Business in China is also gaining strength. Earnings are anticipated to grow 26% over the next five years.
Some other important players in the electrical machinery industry include Emerson Electric Company (NYSE:EMR)., Avt Inc (OTC:AVTC). and ESCO Technologies Inc (NYSE:ESE)
Deere & Company (NYSE:DE): The company has a $29.8 billion business, operating in the farm machinery industry. It is engaged in the production and distribution of agricultural and forestry equipment, construction equipment and engines worldwide. Long-term growth prospects of the company are strong based on increasing global demand for food, shelter and infrastructure. Earnings are expected to grow 8.6% over the next five years.
Some other companies worth mentioning in the industry include AGCO Corporation (NYSE:AGCO), Lindsay Corporation (NYSE:LNN) and Alamo Group Inc (NYSE:ALG).
Illinois Tool Works Inc (NYSE:ITW: The company, with a $35 billion market capitalization, operates in the general machinery industry. It is a worldwide manufacturer of highly engineered products and specialty systems. Development of new products, reasonable cost control and increasing industrial activities worldwide are the prime keys to growth for this company. Earnings are expected to rise 9.3% over the next five years.
Other important players in the machinery-general industries include Nordson Corporation (NASDAQ:NDSN), The Middleby Corporation (NASDAQ:MIDD) and IDEX Corporation (NYSE:IEX).
OPPORTUNITIES
Fiscal government expenditures play a counter-cyclical role by curbing the ill effects of slower economic development and a tight credit market. In China’s structural stimulus package, government spending on social welfare, construction of low-cost housing and completion of infrastructure projects on agriculture, forestry and water resources, received special attention.
Moreover, the U.S. Congress had a stimulus package designed in 2009 that had money flowing into infrastructure spending. Also, the American Energy & Infrastructure Jobs Act (H.R. 7) will boost spending in infrastructure projects. The President’s Fiscal 2015 Budget includes a $302 billion investment proposal for development of surface transportation. This, if approved, will boost industrial products demand as well as create new jobs.
In Sep 2014, the European Central Bank (ECB) stunned the global market by announcing fresh cuts in all interest rates and negative rates on bank deposits. In addition, a stimulus plan, infusing money in the market through purchase of covered bank bonds and asset-backed securities, was also announced. These initiatives are aimed at combating the ill-effects of low inflation in the region. The news weakened the Euro to a 14-month low against the U.S. dollar, while the European stock and bond markets rejoiced the sudden surge in prices.
WEAKNESSES
We remain wary of the rising raw material costs for some of the major players of the machinery industry. Steel prices along with energy, especially coal and fuel prices, remain the prime causes for concern.
At the same time, research and development costs are on the rise for machine makers as they seek to manufacture more sophisticated and technologically advanced machinery. Availability of funds remains a stumbling block as some major nations are still struggling to stabilize their own economies.
Although favorable commodity prices are a boon, government policies affecting prices along with export and import policies and trade relations with other countries, will impact the machinery industry at large.
To Conclude: Promising Prospects
With persistent economic uncertainties in many parts of the world, presence of headwinds cannot be ruled out. Sincere efforts are being made to overcome these hurdles, with greater emphasis on growing trade relations and implementation of better policies. These, along with growing population, require technologically advanced equipment in infrastructure, agriculture, mining and other industries. Moreover, going ahead, the growth path widens for the emerging and developing nations, which will inevitably become rewarding destinations for machine makers worldwide.
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