Worried About the Economy? These CEOs Aren’t
(Bloomberg Opinion) -- In this time of pick-your-own-adventure industrial earnings and economic data, it’s hard to know what to believe. So I teamed up with Bloomberg TV this week for a series of interviews with CEOs of companies that sit at vital cross-sections of the economy to get their view of what’s really going on.
We talked with toolmaker Snap-on Inc., 3M Co., Norfolk Southern Corp., electronics company Logitech International SA and agricultural equipment-maker AGCO Corp. The general tone was one of cautious optimism, and that makes sense, because all of those companies – with the notable exception of 3M – had strong earnings numbers to start the year. AGCO raised its 2019 profit guidance on Thursday after reporting first-quarter sales and profits that were more resilient than analysts were expecting, given challenged global farming conditions. That should bode well for Deere & Co., which is set to report results in two weeks. AGCO’s improved outlook still bakes in a healthy dose of conservatism. CEO Martin Richenhagen said he’s hopeful a U.S.-China trade deal will happen soon, calling the tensions “a homemade problem that we could have avoided.” But a rapprochement won’t necessarily bring a spike in orders. To rebuild growth in China, America needs to “prove that we can be reliable partners in the long run,” Richenhagen said.
Norfolk Southern CEO Jim Squires said his customers – which range from automotive manufacturers to chemical companies and commodity suppliers – are bullish as a group. But volume growth was also flat in the first quarter for the railroad amid a drop in automotive and coal shipments. The appeal of Norfolk Southern is that its stock price momentum is temporarily detached from cyclical economic concerns and dependent more on management hitting the company’s efficiency targets. Norfolk Southern ranks last among the top North American railroads when measured by a key profitability benchmark, which means it has the most room for improvement. The first quarter brought some good early returns on its efforts to close the operational gap with peers, while price increases helped push overall sales up 5 percent. Idiosyncratic stories like that may be the best way to play this hot-and-cold economy. Of note, the Institute for Supply Management index slumped in April to the weakest level of President Donald Trump’s tenure as new orders weakened and inventory stockpiles grew.
Snap-on CEO Nick Pinchuk and Logitech’s Bracken Darrell highlighted pockets of their businesses that should be more defensive in a downturn, should one occur. Snap-on caters to the automotive repair industry and saw a much-anticipated recovery in tool sales to technicians and dealerships in the first quarter. North America’s automotive fleet is 11.8 years old, Pinchuk said, and the aging process doesn’t stop if GDP weakens. If an economic slump erodes consumer demand for Logitech’s gaming controllers, its video collaboration business should benefit as companies look to replace expensive travel with conference calls, Darrell said. Logitech saw 44 percent growth in its video-conferencing business to start the year and expects that division to be a key driver of its expectations for mid-to-high single-digit sales growth in fiscal 2020. And then there was 3M. CEO Michael Roman was asked about why his company was so unprepared for weak demand in the well-known trouble spots of China, automotives and electronics, but I don’t know that his answers illuminated anything for me. Roman said he’s not banking on a second-half recovery in those sectors, which may signal the company’s guidance is finally conservative enough after a series of cuts.
NOT A GAME CHANGER
General Electric Co. avoided disaster in its first-quarter earnings report, but the numbers were nowhere near good enough to prove the worst is behind the company. The stock rallied on the news (up as much as 8.2 percent intraday) and that was largely a factor of two things: First, GE burned $1.2 billion of cash in its industrial businesses, less than analysts had expected; and second, the grounding of Boeing Co.’s 737 Max was the only new risk flagged by management. The cash-flow beat risks being a red herring. Restructuring was one big difference relative to analysts’ estimates, with GE saying the bulk of its cost-cutting push will happen in the second half of the year. CFO Jamie Miller said in an interview that the pace of restructuring had progressed as planned, but some analysts have questioned whether management is moving as urgently to fix the troubled power business as it says it is. The timing of the divestiture of GE’s supply-chain finance program and the earlier-than-expected receipt of advances for some power and aviation orders also benefited cash flow, as would the apparent exclusion of a $500 million cash burn at the divested transportation unit. One interesting thing was that the power unit’s orders appeared to be weighted toward the less risky, more profitable U.S. market as GE continues to duke it out with Siemens AG over an Iraq contract, although Miller said there’s no deliberate geographic shift as part of the company’s efforts to bolster pricing discipline. At the end of the day, GE remains on track to burn as much as $2 billion in cash at its industrial business this year, so there’s no reason to believe the odds of the sharp turnaround it’s promising in 2021 got any better.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
3M agreed to buy wound-care company Acelity Inc. for $6.7 billion in its biggest ever purchase. The timing gives me pause: the deal comes just one week after 3M’s first-quarter earnings bomb and two weeks after Acelity filed for an IPO, suggesting this was a relatively quick turnaround. Asked by an analyst about his ability to juggle weak demand trends, a corresponding restructuring program and the integration of the Acelity deal, CEO Roman said he had “a pretty clear line of sight and focus.” Such a statement might carry more weight if he hadn’t just announced 3M’s fifth guidance cut in a year. 3M will trim its share buyback plans for 2019 as a result of the deal. The best thing you can say about Acelity is that it fits well with 3M’s health-care business and is growing fast now after some lumps over the previous few years. One interesting question is what this deal could mean for a possible 3M breakup. The company’s R&D strength has been the biggest argument against unraveling its conglomerate identity. With 3M now seemingly admitting it wasn’t getting far enough on internal innovation alone anymore, I wonder if the perception of it as the rare industrial that can’t be split holds. When asked for a basic introduction to what 3M does during his interview with Bloomberg TV, Roman pointed to the synergies “that make the enterprise greater than the sum of our parts,” suggesting a justification for the sprawl is top of mind for him right now.
Ingersoll-Rand Plc announced it would merge its industrial division with Gardner Denver Holdings Inc., leaving behind a pure-play HVAC company that will be renamed. There will be several of those floating around: Ingersoll-Rand’s merger news came as Johnson Controls International Plc completed the $13.2 billion sale of its automotive battery unit, leaving it with an HVAC, fire and security business. That divestiture was hardly a done deal amid concerns that banks would have trouble placing the debt for the private equity buyers, so it’s nice to see that close ahead of schedule. Meanwhile, United Technologies Corp. is moving ahead with a spinoff of its Carrier building controls unit. Ingersoll-Rand’s combination with Gardner Denver is structured as a Reverse Morris Trust, making it a tax-efficient way for the company to divest an industrial parts division that’s always been a bit of a hodgepodge and a weird fit with its HVAC business. That being said, the emergence of all these pure plays makes me wonder if the breakup fever is going too far, and if all these splits could leave companies looking naked in a downturn. Consolidation among these newly unshackled HVAC companies could help with that.
Parker-Hannifin Corp. is buying adhesives and coatings maker Lord Corp. for $3.675 billion. The goal is to add exposure to the faster-growing, profitable materials-science market amid a slowdown in orders for its industrial operations. Lord has grown at a compound annual rate of 7.6 percent over the past three years, while Parker-Hannifin has expanded at a 4.1 percent pace. Lord’s adjusted Ebitda margin of 22.8 percent compares to 18.4 percent at Parker-Hannifin. That kind of financial profile doesn’t come cheap, though. Parker-Hannifin is paying 15 times Lord’s expected 2019 adjusted Ebitda, a premium to what’s been paid on average for North American industrial takeovers of size over the past three years. That’s tolerable if Parker-Hannifin can achieve the $125 million in cost savings it’s targeting, but analysts have mixed views on how doable that actually is given the company doesn’t expect many plant closures.
Anadarko Petroleum Corp.’s efforts to sell itself took another interesting twist this week when Warren Buffett’s Berkshire Hathaway Inc. ponied up $10 billion to help finance Occidental Petroleum Corp.’s bid for the company. At first look, this seemed to swing the pendulum in favor of Occidental over counterbidder Chevron Corp. Buffett’s backing theoretically helps mitigate the disadvantages of Occidental’s smaller balance sheet and gives a seal of approval to its stock currency. One investor went so far as to declare Chevron’s pursuit of Anadarko “dead.” But Buffet’s terms weren’t cheap, notes my colleague Tara Lachapelle. And Occidental investors including Matrix Asset Advisors Inc. and T. Rowe Price are wondering if Anadarko is really worth all of this. Their opinions may not matter in the end: Buffett’s involvement will likely reduce the amount of equity Occidental needs to issue in the deal, perhaps eliminating the requirement for shareholder approval. He reportedly was willing to invest as much as $20 billion in Occidental.
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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