This article discusses the outlook of machinery manufacturing companies that cater to the construction and mining markets. Industrial production was up 6% in the second quarter, marking the third consecutive quarterly increase. Manufacturing output has inched up 1.9% at an annual rate in the quarter, while mining output jumped 19%. Gains in the oil and gas sector have supported the expansion of the mining sector so far this year. These upbeat performances highlight that demand for both construction and mining equipment has been encouraging, of late.
Continued improvement in residential and non-residential construction as well as revival in infrastructure demand bode well for the industry. Growth in U.S. GDP and continued improvement in end-use sectors like automotive, aerospace and construction are tailwinds for metals. Mining companies are also resuming capital spending. Further, the recently passed tax reform is likely to act as a catalyst by expediting manufacturing investment in factories, new equipment and other capital goods.
Meanwhile, every manufacturing company is bearing the brunt of raw material inflation due to the recent imposition of tariffs. However, this can be mitigated to some extent with upcoming price increases in 2018. Nevertheless, a full-blown trade war could damage global trade, and provide a real risk to the outlook.
Industry Outperforms S&P 500, Sector
Steady growth in the country's industrial production (from 2.8% in January to 3.8% in June), rise in new orders for the U.S.-manufactured machinery, improving ISM Purchasing Managers' Index - suggest expanding economic activities in the manufacturing sector. Moreover, an improving construction sector, rising commodity prices and increased government spending have reinstated investors' confidence on the Manufacturing- Construction and Mining industry's growth prospects.
The Zacks Manufacturing - Construction And Mining industr y, which falls within the broader Zacks Industrial Products Sector , has outperformed both the S&P 500 and its own sector over the past year.
While the stocks in this industry have collectively gained 21.9%, the Zacks S&P 500 Composite and Industrial Products Sector have rallied 15.1% and 4.9%, respectively.
One-Year Price Performance
Group Trading Cheaper Than S&P 500, Sector
One might get a good sense of the industry's relative valuation by looking at its enterprise value-to EBITDA ratio (EV/EBITDA), which is the most appropriate multiple for valuing manufacturing stocks.
The Manufacturing - Construction and Mining industry is a capital-intensive industry with high fixed costs, the bulk of which is funded through debt. Moreover, these companies have high depreciation expenses due to a large fixed asset base. The EV/EBITDA ratio essentially measures the value of an industrial manufacturing company, inclusive of debt and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.
The industry currently has a trailing 12-month EV/EBITDA ratio of 7.1, which is at the lowest level over a year's time. When compared with the highest level of 12.4 over the past year, there is apparently plenty of upside left.
The space also looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.2 and the median level is 9.75.
EV/EBITDA Ratio (TTM)
Also a comparison of the group's EV/EBITDA ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Industrial Sector's trailing 12-month EV/EBITDA ratio of 14.2 and the median level of 15.5 for the same period are way above the Zacks Manufacturing - Construction and Mining industry's respective ratios.
EV/EBITDA Ratio (TTM)
Outperformance May Continue on Solid Earnings Outlook
Improvement in its end markets like recovery in manufacturing activity, residential and non-residential construction; ongoing recovery in the commodities, oil and gas industry along with economic growth will continue to drive the industry.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry's prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. There is a clear uptrend in both the year's consensus estimates.
Price and Consensus: Zacks Manufacturing - Construction and Mining Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $9.39 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Manufacturing - Construction and Mining industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $9.39 'per share' of the industry for 2018, but how this dollar number has evolved recently.
Current Fiscal Year EPS Estimate Revisions
As you can see here, the $9.39 'EPS' estimate for 2018 is up from $7.45 at the end of March and up significantly from $5.42 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Manufacturing - Construction and Mining industry have been steadily raising their estimates.
The consensus EPS estimate for the current fiscal year has been revised 73.3% upward since August 2017.
Zacks Industry Rank Indicates Improved Prospects
The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.
The Zacks Manufacturing - Construction and Mining industry currently carries a Zacks Industry Rank #36, which places it at the top 14% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry's rank has continually improved substantially over the past three weeks. The industry has remained in the top 50% bracket in five of the trailing eight weeks.
Industry Promises Long-Term Growth
The long-term EPS (3-5 years) growth prospects for the industry look appealing when compared with the broader Zacks S&P 500 composite. The group's mean estimate of long-term EPS growth rate has been increasing since January 2018 to reach the current level of 14.2%. This compares with 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-terms EPS growth could be recovery in the top line that companies in this industry have been showing since the end of third quarter of 2016. In fact, the upward movement is still on.
Another important indication of solid long-term prospect is the improvement in the group's return on equity (ROE), which is a key metric for evaluating manufacturing stocks. After touching its lowest point in second-quarter 2016, return on equity for the Manufacturing - Construction and Mining industry is improving.
The overall economy and leading economic indicators provide general insight into projecting the industry's growth. The Manufacturing - Construction and Mining industry seems poised to deliver earnings growth and respectable returns in the near term despite trade worries. This combined with cheap valuation make this industry a lucrative option for investors seeking exposure in the U.S. Manufacturing - Construction and Mining space.
Investing in companies with solid earnings potential and favorable Zacks Rank #1 (Strong Buy) or 2 (Buy) can be good investment strategy. (You can see the complete list of today's Zacks #1 Rank stocks here .)
Stocks to Bet on
Caterpillar Inc. (CAT): The Zacks Consensus Estimate for the current-year EPS for this Deerfield, IL-based manufacturing and construction equipment has been revised upward by 7% over the last 60 days.
Price and Consensus: CAT
The Manitowoc Company, Inc. (MTW): The consensus EPS estimate for this Manitowoc, WI-based crane manufacturer has moved up by 4% for the current fiscal year, over the last 60 days.
Price and Consensus: MTW
Below is a stock that carries a bearish Zacks Rank that we would recommend investors to stay away from for the time being.
Astec Industries, Inc. (ASTE): The consensus EPS estimate for this Chattanooga, TN-based company dipped 2% for the current fiscal in the last 60 days. The stock has dipped 2% in the past year.
Price and Consensus: ASTE
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free reportThe Manitowoc Company, Inc. (MTW): Free Stock Analysis ReportCaterpillar Inc. (CAT): Free Stock Analysis ReportAstec Industries, Inc. (ASTE): Free Stock Analysis ReportTo read this article on Zacks.com click here.Zacks Investment Research