Industrial Earnings Are as Mixed as the Economy

(Bloomberg Opinion) -- The industrial earnings season so far is heavy on boogeymen and light on clarity. I’d been hoping that manufacturing companies’ updates on the first three months of the year would help sort out economic data that’s pointing every which way, but midway through the releases, it doesn’t appear we’re any closer to a readable trend line.

The growth is still there, if you know where to look for it. But some markets are visibly challenged, others are complicated by idiosyncratic issues and still others are pitched as second-half turnaround stories that seem risky, at best. I was struck by this comment from Honeywell International Inc. CEO Darius Adamczyk last week after the company reported strong organic sales throughout its businesses and raised its growth guidance for the full year: “What we’re wondering is, are we unique or is there something else that’s going on in the market here that maybe hasn’t hit us yet?” I’d imagine a lot of companies are feeling the same way. Caution seems the appropriate course as they sift through the hodgepodge.

Industrial distributor W.W. Grainger Inc. kicked off the week with disappointing sales growth in a quarter with many puts and takes. United Technologies Corp. knocked it out of the park with 8 percent organic growth, but that was largely fueled by its aerospace units and RBC analyst Deane Dray says weaker-than-expected housing starts put the outlook for its Carrier HVAC unit at risk. Norfolk Southern Corp. is overcoming slow volume growth with pricing increases and ahead-of-schedule progress on its new efficiency plan. Caterpillar Inc. is in the opposite position: Its slowing growth was mitigated by a rebound in its mining unit, but margins in the construction and energy and transportation business took a hit amid rising manufacturing costs. The company warned aggressive pricing in China would eat into its returns there. Rockwell Automation Inc. and Fortive Corp.’s earnings both fell into this same mixed-bag territory; the sluggish automotive market forced the former to cut its 2019 organic sales guidance, while weak measuring and monitoring equipment sales dragged down Fortive’s results as it grapples with an inventory hangover from a rush of pre-buying ahead of tariffs in the U.S.-China trade war.

3M Co. whiffed the hardest, cutting its guidance for the fifth time in the past year. The company cited well-known troubles in China and the automotive and electronics markets, but the sales weakness was surprisingly broad. It’s hard to know how much of that is evidence of a widespread slowdown and how much can be attributed to 3M’s own mismanagement of its businesses and investors’ expectations. One additional point: it’s weird that 3M repurchased $701 million in shares as its stock was on the rise in the first quarter. Did the company honestly not know that its businesses were moving in the opposite direction of the stock? Inge Thulin, the outgoing chairman and former CEO, was selling shares during the same period. While that appears to be in conjunction with a trading plan, it’s still a bit awkward.  

MAXED OUT
After all the buildup around Boeing Co.’s first-quarter earnings release, the actual event was rather anti-climatic. CEO Dennis Muilenburg was tight-lipped about when the company expects regulators to allow its 737 Max to return to the skies after two fatal crashes spawned just the second fleet-wide grounding of a plane by the Federal Aviation Administration since 1979. Boeing suspended its guidance, temporarily paused share buybacks and left the door open to further cuts in its production pace for the Max. It hasn’t made any assumptions on contractual liabilities, but it’s hard to believe those won’t exist. American Airlines Group Inc. said the grounding would shave $350 million off its 2019 pretax profit. The airline is confident the Max will be recertified by mid-August, and you can see why it might want to think that. But as United Continental Holdings Inc. CEO Oscar Munoz told Bloomberg TV, you can’t take a piecemeal approach to this. The difficulty of wrangling a consensus out of global regulators who are increasingly operating independently from the FAA makes an August return seem a tad ambitious. Perhaps most troubling for Boeing, Southwest Airlines Co., which has exclusively used 737s since its introduction in 1971, seems less than committed to that dynamic. Also of note, it’s interesting that PT Garuda Indonesia executives included a yet-to-be-developed Boeing 797 mid-range plane among alternatives to replace the airline’s Max order. Boeing said it’s continuing to evaluate that project.

24-HOUR HEADACHE
Amazon.com Inc. announced this week that it’s working to reduce the standard delivery time for Prime customers to just one day. This is a smart move that will help Amazon protect membership in its $119-a-year Prime program when traditional retailers are finally starting to become e-commerce juggernauts in their own right, making the previous two-day standard less of a selling point, as my colleagues Sarah Halzack and Shira Ovide note. Amazon says it will need all available levers, including third-party delivery partners such as United Parcel Service Inc. and the U.S. Postal Service, to execute this goal, but it also emphasized the more than 20 years it has spent expanding its own fulfillment and logistics network. “We'll just see how it develops going forward,” said Chief Financial Officer Brian Olsavsky. It’s hard not to view this as a step toward making Amazon itself a bigger destination for logistics management. If it makes one-day shipping the new standard, other retailers will likely have to follow and Amazon will be one of the few companies able to help them do that. UPS and FedEx Corp. are already straining to adapt their networks to the current deluge of e-commerce shipments and a two-day window. They don’t have the ability to casually announce a surprise $800 million investment in network revamps in one quarter. But they’ll have to try to keep up with the demands for ever-faster shipping, and that makes a reduction in their capital expenditures or a leveling off in their margin erosion look increasingly unlikely.

DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
United Technologies
CEO Greg Hayes said this week that the window of opportunity is shrinking for the company to sell rather than spin off its Carrier unit or Otis elevator division. The company isn’t interested in doing a deal that would throw off its timeline of having the two businesses separated by the first half of 2020, and any merger would entail potentially lengthy antitrust scrutiny. It seems likely that consolidation will still happen in the HVAC sector; it just may not be as soon as investors had been expecting. But waiting isn’t such a bad thing: Carrier would have more deal options as a separate entity. Hayes had also stipulated that any deal be tax-free, as a spinoff would be, which made Johnson Controls International Plc one of the more likely contenders because it would be roughly the right size for a Reverse Morris Trust. A standalone Carrier may have an easier time structuring a merger with the smaller Lennox International Inc. Getting antitrust regulators’ blessing for that deal is a different question.

Anadarko Petroleum Corp. now finds itself the target of a full-blown bidding war. Occidental Petroleum Corp. this week made a cash and stock counteroffer for Anadarko. Even after a slide in its shares on the news, that bid is worth about $75, or around 20 percent more than the current value of Chevron Corp.’s bid for the company. Occidental’s proposal also includes more cash, as well as pointed jabs at Anadarko’s management for its failure to engage with the company. But as my colleague Liam Denning writes, Occidental is clearly the underdog in this fight. The deal will have a much bigger impact on Occidental’s smaller balance sheet, forcing it to sell assets and likely limiting its ability to buy back stock in the near term. And Chevron, which has more overlap with Anadarko, should be able to afford a higher bid on the back of greater cost savings. Chevron seemed rather nonplussed about the whole thing on a call to discuss its earnings Friday, saying it had already begun integration talks with Anadarko counterparts.

JR Automation Technologies, a company backed by private equity that integrates robotics into manufacturing plants, agreed to sell itself to Hitachi Ltd. for $1.43 billion. The business will complement Hitachi’s recent acquisition of KEC Corp. (basically a Japanese version of JR Automation) earlier this year and its Lumada Industrial Internet of Things software platform. It certainly seems like a good outcome for Crestview Partners, which acquired JR Automation in 2015 when it had about $170 million in sales. It now generates more than $600 million in revenue.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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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