Knowledge. Shared Blog

July 2019

Industrials’ Q2 Earnings: A Tale of Two Cities

Industrials are about halfway through the Q2 earnings season, and the results suggest uncertainty around the economic outlook. David Chung, Research Analyst and Industrials Sector Lead, explains what investors should consider now.

Key Takeaways

  • Looking at Q2 earnings, the industrials sector seems to be splitting into two categories: On one hand, longer-cycle or consumer-facing firms that are delivering solid growth; on the other, short-cycle businesses that are confronted with headwinds.
  • The question now is how long these headwinds could last. Are they leading indicators of a recession or simply a mid-cycle slowdown?
  • Given this backdrop, we believe investors should remain focused on industrials firms that are delivering differentiated organic growth, undertaking “self-help” margin initiatives or deploying capital smartly.
View Transcript

David Chung: Q2 earnings season is underway. We’re about halfway through, and so far I’d really describe it as a tale of two cities. So on one hand, you have companies with long-cycle businesses, longer visibility, aerospace and defense, or more consumer facing. So, airlines, e-commerce, residential, non-residential, construction, those have been pockets where you’ve seen pretty good growth and it’s been quite resilient. On the other hand, you have short-cycle businesses, less visibility, lower backlogs that are more tied to the trends within the general industrial and heavy manufacturing end markets, those have been quite weak. And then also, certain end markets like autos and electronics, which have had air pockets for their own issues.

And so what we’re debating right now is how real is this short cycle slowdown? Is it an indicator of we’re heading into a recession, is it a leading indicator of that? Or, is it more of a mid-cycle pause? And what makes things challenging is that, you know, in May, is when we really had the trade war escalate with President Trump’s tweet. And that really got worse until G20, which the summit was sort of a ceasefire and truce, but that was on June 29, conveniently the last day of the quarter. And so, it’s really hard to make too much of a read into the timing of these reports and what they’re seeing versus further trends to extrapolate into the future.

So given this backdrop, how are we investing behind this? We continue to monitor things daily and weekly in terms of the data points and the earnings results, but we do think a couple of things are helping towards this. One is a stable to improving trade narrative. It could change daily, as we’ve come to find out. But we do think that’s stabilizing. In addition, a favorable interest rate environment could also give business leaders the confidence to put forth some of these investments in the future, which would drive growth.

In terms of the stocks, we really focused on three areas. Given that the end market is so volatile and uncertain, where we’re focused on three areas. One, where can companies drive differentiated organic growth that’s above and beyond the end markets that they serve? We call it decoupling from just industrial production or PMIs or what have you.

The second bucket is self-help margin initiatives. So margin expansion not driven on pure volume growth. And so areas of productivity, cost reduction efforts, are really areas that we gravitate towards to.

And then third would be capital deployment opportunities to create value. And that can come in the form of share buybacks if the stocks are trading at really attractive prices. We love to see companies get aggressive there. Or it can be M&A and acquisitions into secular pockets of the economy where they aren’t in today. It could also mean divestitures, underperforming businesses within the company, they can get an attractive price and deploy it into higher return areas. So we don’t want to be subject to the cycle and make a macro bet purely, but are constantly looking for investment opportunities where they can determine their own future.

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