Jefferies Looking For 'Green Shoots' In Machinery Stocks: What That Means

Analysts at Jefferies said they "don't expect much from the first quarter earnings season" in the machinery sector, despite some encouraging macro industrial data.

"1Q is the seasonally weakest quarter of the year, and with many company forecasts 2H loaded already we don't expect increases in guidance. But order activity may be better against easy comparisons, and currency should be a relative tailwind," analysts led by Stephen Volkmann wrote in a note to clients.

In this scenario, Volkmann said he is looking for "green shoots," a term used to describe signs of economic recovery or positive data during an economic downturn.

Got To Find The Green

"Positive trends in currency (weaker dollar) through the quarter and recent macro level indications that destocking could be abating sooner than originally anticipated are positives for the sector," Volkmann said.

"However, we still think it's too early to see much positive evidence in the 1Q earnings," he added.

Related Link: Titan Machinery Reiterates FY17 Expectations

The analyst continued, "Overall, we anticipate in-line to slight beats for most of our coverage with annual guidance being unchanged. There are a few exceptions to this such as MTW and potentially the ag and mining names, where the revenue bar will may need to be lowered as order trends do not appear to have accelerated enough to support initial projections."

Expectations

Volkmann noted that "despite the low commodity price environment most of our companies commented during the 4Q earnings season that have or will be issuing modest price increases for 2016. While there is a normal level of haggling with customers surrounding price actions, management teams have indicated that price will provide a tailwind in 2016, though likely to a lesser degree than in 2015."

The analyst added that lower prices for raw materials would aid margins.

"With input costs continuing to decline and manufacturers committed to (marginal) price increases we do anticipate associated margin expansion to occur by at least 2H16. We had been anticipating a net-benefit of upwards of 100bps in 2H15, though lower sales volumes across the sector prevented some of this," Volkmann elaborated.

He continued, "Companies broadly have been speaking of a 20–40bps net price/cost benefit for 2016, which could prove conservative should volumes improve."

A Few Names

The analyst noted that "based on current corporate guidance and current Street forecasts there is an expectation for a significant increase in 2H earnings for several Machinery companies. Companies most weighted to 2H include: Manitowoc Company Inc MTW, Titan International Inc TWI and Oshkosh Corp OSK."

Meanwhile, Volkmann look to "short cycle" names like Kennametal Inc. KMT, Timken Co TKR, Parker-Hannifin Corp PH and Ritchie Bros. Auctioneers (USA) RBA "to potentially show some signs of order improvement against easy comparisons."

He stated that the following "agriculture, truck and mining names may need to lower industry forecasts given that sales trends in these end markets have run below forecasts in the 1Q."

• Deere & Company DE and AGCO Corporation AGCO in agriculture
• PACCAR Inc PCAR and Cummins Inc. CMI in truck
• Caterpillar Inc. CAT and Joy Global Inc. JOY in mining

"We expect the bifurcated machinery cycle to continue -- one in which commodity related weakness will persist but where pent up replacement demand in non-commodity machinery markets can drive another leg to the cycle once inventories are normalized. We prefer exposure to housing, commercial construction, infrastructure, general factory and transportation, including trucks," the analyst added.

Following are Volkmann's picks in various categories: "Favorite names near term: Defensive" All Buy Rated

• Ingersoll-Rand PLC IR
• Illinois Tool Works Inc. ITW
• PACCAR Inc

• Oshkosh Corp
• Ritchie Bros. Auctioneers
• Terex Corporation TEX

• Caterpillar
• Deere & Company
• Joy Global

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