Which Stocks Are Working in the Industrial Sector?
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It’s always interesting to use earnings season as a way to formulate a view on the economy. Unfortunately, anyone looking for some positive news on the industrial sector would have been disappointed by the recent results from industrial supply companies Fastenal (NASDAQ: FAST) and MSC Industrial Direct(NYSE: MSM). What did these companies say, and what does it all mean for the industrial sector?
Mixed growth in the industrial sector
In short, outside of areas like aerospace and aviation, the industrial sector remains weak. Earlier in the week, aluminum supplier Alcoa (NYSE: AA) came out with a positive report that gave cause for optimism.
The company always gives good color on its industrial end markets, and the fact that it failed to reduce guidance for China has to be taken as a positive. The good news on China was somewhat surprising because companies like FedEx, Pall, and Oracle have all come out and stated specific weakness in China. Nonetheless, we should take what Alcoa said at face value.
Similarly, Alcoa’s global aerospace, automotive, and industrial gas turbine segments remain set for good growth in 2013, even if Europe is a little weaker. Since Alcoa is saying good things, surely the industrial supply companies would, too? They are always useful as a bellwether because their sales cycle is relatively short. This means that any change in conditions will immediately be seen in their sales figures.
Fastenal adjusts its strategy
Unfortunately, Fastenal and MSC Industrial both had negative outlooks on the industrial sector.
Fastenal spoke of a slow economic condition causing its fastener sales (a cyclical product) to remain weak. In a sense, this apes the overlying Institute for Supply Management (ISM) manufacturing numbers, which have been softer in 2013. The ISM surveys private manufacturing companies in order to produce its Purchasing Managers Index (PMI), which is the leading manufacturing indicator in the U.S.
Note how the strength in new orders (which usually precede a pick-up in the headline PMI numbers) quickly dissipated in February, while the headline PMI number has averaged 49.7 this year. A number below 50 indicates negative growth.
In fairness, Fastenal did point out in the previous conference call that its sales were not represented by the stronger ISM data in the first quarter (ISM new orders had averaged 54.2 in the first three months). However, this historical relationship came back into line in the second quarter as both the ISM and Fastenal’s sales growth was weaker.
The company’s response is to try to drive sales by making significant new hires (mainly sales support staff) in its stores. The idea is to hire 600-900 new in-store staff by the end of the year. The plan would enable its existing managers to have more free time to visit more customers, increasing sales accordingly.
It’s an interesting approach, because previously Fastenal’s main focus was on expanding the installations and sales of its vending machines. However, with competitors like MSC Industrial also building out its vending machines and Amazon increasingly moving in on the industrial supply market, Fastenal may feel that a balanced approach to growth is a better way to deal with a slow industrial market.
MSC Industrial also weak
The theme of adjusting to macro weakness was shared by MSC Industrial. The company decided against implementing its mid-year pricing increase in a concession to a softer demand environment. It’s tough to get customers to accept price increases at the best of times, let alone when end demand is weak. The good news for MSC Industrial is that it has non-cyclical ways to increase profitability:
- The acquisition of Barnes Distribution North America will increase revenues, margins and create opportunities.
- Its e-commerce revenues are growing at north of 40%.
- It has the potential to increase vending machine installations.
Obviously, these three aims are easier to achieve given a stronger demand environment, and if you buy the "second-half industrial recovery" story, then MSC and Fastenal are interesting propositions. On the other hand, until the headline ISM manufacturing indices improve, investors should brace themselves for more disappointments and negative sentiment around the sector.
In comparing the two companies, MSC Industrial comes out on top in terms of valuation and potential to grow earnings despite the economic cycle.
The bottom line
In conclusion, these results told similar story to the first quarter's about MSC and Fastenal and their end markets. It appears that Alcoa’s optimism is more related to the strength of some of its particular industry segments, such as aerospace and automotive. Investors in Fastenal and MSC would do well to ignore Alcoa and focus more on the ISM numbers in order to see where prospects for the two companies are headed.
Alternatively, there is a strong case for simply staying invested within the areas of strength in the industrial sector. It’s too early to proclaim a general second half pick-up.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends MSC Industrial Direct. The Motley Fool owns shares of MSC Industrial Direct. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!