The Early Readout on Industrial Earnings
(Bloomberg Opinion) -- After all the predictions of doom and gloom, it seems December wasn’t all that bad for industrial companies. But with economic data pointing every which way, it’s wise to be cautious. Federal Reserve data released Friday showed U.S. factory production expanded in December by the most in 10 months, after a decline in October and a revised modest 0.1 percent climb in November. That contrasts with a December plunge in the Institute for Supply Management’s manufacturing gauge that was the biggest since the recession. And slowdown worries appeared in the Federal Reserve’s Beige Book economic survey released this week.
That mix of optimism and pessimism has carried over into early earnings reports. On the one hand, shares of industrial distributor Fastenal Co. surged Thursday as a 14.5 percent jump in December sales convinced investors to look past yet another gross-margin miss. At Sherwin-Williams Co., however, a December sales recovery failed to make up for weak numbers in October and November, prompting the company to warn it would miss its 2018 adjusted earning-per-share guidance. Its shares slumped. Sherwin-Williams’s management was at a loss to explain the sales pattern, dismissing weaker housing markets, the government shutdown and its recent price increases as possible factors, while acknowledging rainy weather in the Eastern part of the U.S. could have played a role.
Weather is a notoriously feeble excuse, and it’s not encouraging for a management team to lack an explanation as to why their company’s sales varied so significantly from expectations. That said, Sherwin-Williams’s shoulder shrug may end up being one of the more honest answers we’ll get this earnings season to questions about the outlook. It’s heavily dependent on what your crystal ball says about the trade war and government shutdown, but either way, things are slowing down. It was interesting to me that CSX Corp. CEO Jim Foote brushed off recession worries because “when you get a real recession, the volumes drop off really fast. That’s not happening.” To point out the obvious, just because volumes didn’t fall off a cliff in December, it doesn’t mean that’s not coming.
One thing that could increase the chances of a recession is the government shutdown, which is now in its 28th day. First-quarter growth estimates are dropping across Wall Street, with JPMorgan Chase & Co. CEO Jamie Dimon warning U.S. GDP could fall to zero if the shutdown lasts through March. With no end in sight for the dispute over funding for a border wall, such an extreme outcome is within the realm of possibility. The University of Michigan’s U.S. consumer sentiment index fell to its lowest level since October 2016, according to a report released Friday that was based on preliminary January data. Delta Air Lines Inc. highlighted the shutdown as one factor that will weigh on its pricing power in the first quarter. It estimates the decline in travel by federal employees is costing it $25 million a month in sales. Meanwhile, absenteeism at border checks could contribute to a pile-up there similar to what we’re seeing at U.S. airports. That risks further ballooning freight costs at a time when higher shipping fees are already eating into margins. Fastenal called out higher freight costs as one factor for its fourth-quarter margin miss.
THE MORE THINGS CHANGE
General Electric Co. this week tapped UBS Group AG analyst Steve Winoker to become its head of investor relations, a smart hire that should bring more credibility to its messaging. But then the industrial conglomerate, struggling under the weight of an estimated $100 billion in net liabilities, said it would pay a $2 million annual salary to John Rice, the former vice chairman it brought out of retirement to supervise the overhaul of its power unit. That’s a higher salary than many CEOs receive, including former GE chief John Flannery, and Rice is only working part time. I understand $2 million isn’t a whole lot for a major corporation. But as an activist investor once put it to me, if you justify your costs by comparing them to something else, you are thinking about it the wrong way. You should be asking why that cost exists at all and what sort of message it sends. Rice’s salary perfectly encapsulates the profligate thinking that turned GE from a Six Sigma champion into a bloated cautionary tale. It blows my mind that the board decided it was a good idea to give an exorbitant payout to a guy who already pocketed millions during his 39 years at GE and will undoubtedly oversee layoffs in his new role.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
Arconic Inc. is still trying to sell itself. The Wall Street Journal reported Tuesday that a deal with Apollo Global Management at $21 to $22 a share could be imminent, echoing a Bloomberg News report that said the parties were targeting a mid-January announcement. I’ll believe it when I see it. This has been a very leaky, drawn-out sales process and when that happens, the result is usually messy and risky. One remaining obstacle is Apollo’s ability to secure a boatload of high-yield financing amid a volatile market. The Wall Street Journal reported the recent thaw may have eased the path to a deal; perhaps the market is trying to tell Apollo something, though. The debt required for this buyout will push Arconic’s leverage above what’s typical for single-B rated companies and it’s currently scored at Ba2, notes Bloomberg Intelligence’s Matthew Geudtner.
Dover Corp. agreed to buy car-wash equipment maker Belanger Inc. this week. Terms weren’t disclosed, but Dover said Belanger generated about $55 million in sales in 2018 and the purchase price works out to an Ebitda multiple of less than 10 times, before accounting for synergies. The deal is complementary to Dover’s fueling systems for gas stations, but it’s not the not the kind of purchase that will get investors fired up or make a meaningful difference to Dover’s operating profile. RBC analyst Deane Dray points out that car washes are a discretionary spending decision; as such, you could question the wisdom of this investment amid all the debate about a possible recession.
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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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