This analysis is by Bloomberg Intelligence Industry Analyst Mustafa Okur and Bloomberg Intelligence Senior Industry Analyst Karen Ubelhart. It appeared first on the Bloomberg Terminal.
US multi-industrials such as Eaton, Fortive and Dover have reduced exposure to volatile end markets like energy over the years and may fare relatively better in a potential recession when compared with prior downturns and also vs. machinery companies. Fundamentals of the latter, including Caterpillar, Paccar and Terex, have historically been more correlated with US industrial production.
Multi-industrials better placed to weather IP fall vs. machinery
Sales growth of multi-industrials and diverse electrical-equipment companies such as Amphenol, Fortive and Honeywell appear less exposed to a potential decline in US industrial production (IP) next year. That’s compared with machinery peers and more narrowly focused large-cap industrials, based on our historical regression analysis of the past 14 years. In this group, historical correlations may also overstate sales risk. For example, Dover and Eaton have divested cyclical businesses. Among machinery, Terex and Paccar look more exposed, whereas Deere and AGCO’s sensitivity is closer to multi-industrials peers as their fundamentals are tied closely to crop prices.
The R-squared IP correlation for some — such as Oshkosh, JCI and Deere — is low, suggesting their organic growth variance may not be linked as strongly to IP.
Jury is out on portfolio simplification in global downturns
The trend among multi-industrials to simplify their portfolios may be tested as global economies veer toward recession. Many US industrial companies have divested significant portions of their assets and have exposure to fewer end markets. In past cycles, a diverse customer base and products, global exposure and active portfolio management generated lower sales and earnings fluctuations than more economically sensitive companies like Caterpillar and Deere. Large industrials’ 3% average revenue growth in the past decade modestly trailed the 4% rate for construction-machinery makers, but with more stability and higher returns, which led to higher multiples.
Honeywell and ITW remain fairly diversified and may fare better in a downturn. 3M’s spinoffs of its health-care and food-safety units could increase earnings volatility.
2015-16 better guide for margin risk than prior recessions
A recession in 2023 could pressure operating margins, yet elevated backlogs and strong pricing may limit the decline to an average of 100 bps, more akin to 2012 vs. prior recession years. Companies ranging from Fortive to Rockwell Automation have acted to reduce cyclical exposure and boost recurring revenue. Eaton and Dover have respectively divested their Hydraulics and Energy units, which were more volatile than the rest of the company. Eaton also sold part of its transmission business. Parker-Hannifin remains very sensitive to IP, though with aerospace company Meggit’s addition, high-margin Aviation represents 25% of sales and is in the early stages of a recovery.
Machinery makers such as Caterpillar, Paccar and Terex remain most exposed to a down cycle as their end markets are closely tied to economic activity.
Reduced diversity may test multis’ premium valuations
With more narrowly focused portfolios amid a weaker global economic outlook, large-cap industrials could face more economic sensitivity than in the past. Multi-industrials historically have earned higher multiples than peers such as machinery and other industrials that are more cyclical, reflecting lower earnings volatility and stronger returns. A Bloomberg Intelligence gauge of North American multis traded at an average EV-to-Ebitda multiple premium of 42% vs. the US machinery sector in the past 10 years and a 16% premium to the broader industrial peer group. During that period, large-cap diversified industrials’ average return on invested capital of 12.2% compared favorably vs. the machinery sector’s 7%.
US dominates sales; Europe represents just over a fifth
US industrials derive around a quarter of their revenue from Europe, where economic growth appears to be slowing at a faster pace than in the US, compounded by energy dependence on Russia. Among machinery makers, AGCO and CNH Industrial have a relatively high exposure to Europe. North America, predominantly the US, remains the most important end market for BI’s industrial coverage of that region, as it represents more than half of sales.
Among multis, GE and TE Connectivity have relatively high exposure to Europe, the Middle East and Africa. Production rates at European automakers affect the latter company’s revenue.
Bloomberg
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