PREVIEW-Industrial earnings to show evidence of recovery

* United Tech, Honeywell, Ingersoll report this week

* Caterpillar, Tyco, 3M results next week

* Industrials outperform as expectations rise

By Nick Zieminski

NEW YORK, April 19 (BestGrowthStock) – For U.S. industrial
companies, this quarter’s earnings season could bring the first
concrete evidence an awaited economic recovery has arrived.

Industrial stocks have outperformed the broader market
heading into the earnings season amid expectations many will
beat Wall Street forecasts and tell investors to expect better
times ahead.

Such companies face a number of positive factors this
quarter. Deep cost cuts during the downturn mean better magins
will exaggerate earnings growth with even modest increases in
revenue. Export markets like China and Brazil are booming. And
early-cycle markets in the United States, including those tied
to the consumer, appear to be staging a comeback.

Jim Owens, boss of heavy equipment maker Caterpillar Inc
(CAT.N: ), is sounding more optimistic about the world economy
than he has in years.

“We’re seeing a pretty sharp V in demand for a lot of our
products,” Owens told President Barack Obama’s Economic
Recovery Advisory Board in Washington.

Owens is hardly alone. That upbeat mood has carried over
into the stock performance of cyclical manufacturing companies,
whose shares typically move up and down with the economy.

A chart of industrial stocks resembles a V: An S&P cap
goods index (.GSPIC: ) has more than doubled from March 2009
lows, beating the broader S&P 500 (.SPX: ). Industrials have also
outperformed since the last earnings season, leading some
investors to question whether valuations are overly bullish.

Most industrial companies will meet or beat expectations,
predicts David Weaver, president of investment company Adams
Express Co. (ADX.N: ), which is overweight in industrials like GE
(GE.N: ), Emerson (EMR.N: ), United Technologies (UTX.N: ), and
Illinois Tool Works (ITW.N: ).

“I’ll be watching, will they show enough confidence to
raise the full year, or do they even start talking about
dividend increases,” Weaver said.

Jensen Investment Management has added to its industrial
holdings companies United Tech, Emerson and 3M (MMM.N: ).

“Industrial names have looked more attractive,” said Jensen
Principal Eric Schoenstein. “For the time being, everything is
in pretty good shape.”

While year-over-year improvements will likely be strong,
more telling will be sequential earnings growth, he said.
Rather than looking for higher profit guidance, Schoenstein
hopes for signs companies are putting cash to work, for example
by increasing merger and acquisition activity. That would
signal management’s confidence in the recovery.


Even if the season brings good results, stumbling blocks
await. Inflation could become a threat, interest rates have
nowhere to go but up, and worries persist over U.S. commercial
real estate, a key market for many manufacturers. Then there is
the prospect that China will overheat; its economy is growing
at an annual rate of nearly 12 percent.

Another earnings uncertainty lingers: whether companies can
charge higher prices to offset costs. So far, signs are that
they can, said analyst Holden Lewis of BB&T Capital markets.
Regal-Beloit Corp (RBC.N: ), Fastenal Co. (FAST.O: ), and Baldor
Electric Co. (BEZ.N: ) have cited pricing power.

“Come second half, raw materials will present a problem if
you can’t move pricing through,” Lewis said.

Commodity inflation can trip up manufacturers that use raw
materials to produce and ship their goods. Copper has doubled
from a year ago; oil has stayed above $80 a barrel throughout
April. Steel prices are lower than before the recession amid
reduced auto demand, but they, too, have rebounded.

“Bigger than anything else is what happens to oil, as
consumption resumes,” said Tom Villalta of Jones Villalta
Funds, who also sees a potential obstacle from the rise of the
U.S. dollar, especially against the euro. The dollar’s strength
could become “a headwind” for U.S. exporters if debt problems
spread from Greece to other European economies.


Profit expectations have risen, making shares more
expensive, since Honeywell (HON.N: ) and Danaher (DHR.N: ) raised
first-quarter estimates in late March. Danaher, GE and Eaton
sell for about 19 times expected earnings, well ahead of the
S&P 500’s (.SPX: ) price-earnings ratio of about 14, according to
Reuters data. Industrial stocks have more than doubled from the
bottom, even as long-term 2011 earnings estimates have only
nudged up by 15 percent, note analysts at FBR Capital Markets.

During the downturn, companies like SPX, Cooper, Crane and
ITW cut workforces by 15 percent or more. That will now drive
margins. For SPX (SPW.N: ) and Tyco (TYC.N: ), earnings per share
will likely go up more than 3 percent for every 1 percentage
point increase in sales, according to FBR.

Such optimism is increasingly widespread. A quarterly
business outlook survey by the Manufacturers Alliance/MAPI, an
industrial leading indicator, is at its highest level since
June 2004; its profit margin index doubled from December. A
Conference Board gauge of the economy’s prospects rose for the
12th straight month in March to a record. [ID:nN19175994]

One sign of the recovery is that some early-cycle companies
— such as Grainger, MSC Industrial (MSM.N: ) and Lincoln
Electric (LECO.O: ) — are already seeing higher costs, such as
reinstating 401(k) matches or bonuses, BB&T’s Lewis said.

Evidence of recovery is not limited to industrials, said
Peter Zuger of Lee Munder Capital, manager of the Touchstone
Mid Cap Value Fund. Retail same-store sales are up, railroads
like CSX (CSX.N: ) are shipping more goods, and demand for trucks
is returning. All point to a “decent recovery,” he said.

Still, expectations may be getting ahead of themselves.
Zuger cited shares of iron ore company Cliffs Natural Resources
(CLF.N: ), a stock that more than tripled between its low a year
ago and its 52-week high this month.

“At some point, I worry it may be hard for even a good
recovery to deliver,” Zuger said. “It may be the early stages
of some irrational exuberance.”

(Additional reporting by Ross Colvin in Washington, James
Kelleher in Chicago, Scott Malone in Boston; Editing by Bernard

PREVIEW-Industrial earnings to show evidence of recovery