Markets & Finance

Industrial Stocks: A Smokestack Comeback?


The recession is still hurting profits, but there are hints the manufacturing economy might be slowly coming back to life

The rapid deterioration of U.S. industry might finally be slowing. If only it would stop.

Industrial production fell 0.4% in June, according to figures released on July 15. U.S. industry was using only 68% of its capacity, the lowest level since the measurement began in 1967.

But economists and investors were expecting a bigger production decline. "The rate of decline at the end of the quarter slowed sharply," John Ryding of RDQ Economics noted.

U.S. industrial production had plunged 13% in the last quarter of 2008, tumbled a further 19.1% in the first quarter, and fell 11.6% in the second quarter. According to Action Economics, June's relatively mild reading suggests industrial production will fall "only" 4% this quarter.

Earnings Optimism

That optimism—if that's the right word—is echoed by some of the latest earnings results.

Industrial distributor W.W. Grainger (GWW) said on July 15 that sales fell 13% last quarter, while earnings per share fell 15%.

"Looking forward, we have yet to see any sign of a pickup in demand," William Chapman, Grainger's director of investor relations, told analysts. "The good news is that the steep decline that began in the 2008 fourth quarter has moderated for now, and things have not gotten worse."

Many customers continue to slash orders. Grainger said sales from heavy manufacturing firms dropped almost 30%. Sales to governments were up slightly, while sales to commercial customers fell by a percentage in the "high single digits."

Uncertainty about the economic future is reining in investor enthusiasm about companies like Grainger. "The lack of visibility in the U.S. economy holds us back from assigning a more positive rating on the shares at this time," wrote Wells Fargo (WFC) analyst Allison Poliniak-Cusic, who gives the stock a neutral market perform rating.

Lighter Loads

Another view of the industrial economy comes from the transportation firms that link up U.S. manufacturers and suppliers. One of the most prominent, trucking firm J.B. Hunt Transport Services (JBHT), saw its shares drop 9.8%, to 26.72, on July 15 after disappointing earnings.

Not surprisingly, the recession is taking a big bite out of trucking profits. J.B. Hunt's earnings per share last quarter were 23¢, way off Wall Street analysts' prediction of 31¢ per share.

U.S. companies have slashed the amount of freight they ship, and trucking companies have been hit hard. J.B. Hunt and other truckers are fighting over fewer shipping orders, forcing them to cut prices to the bone.

A smaller J.B. Hunt competitor, Heartland Express (HTLD), reported earnings on July 14, declaring in a company release: "This extended economic downturn is the worst experienced in the history of our company. There continues to be excess capacity in our industry combined with the continued decline in available freight, resulting in extreme pressure on freight rates."

Signs of Hope

Still, even in the beleaguered trucking industry, there are small signs of hope. "We saw evidence in the current quarter of gradual improvement in demand, which has been soft for years," J.B. Hunt President and Chief Executive Kirk Thompson said in a statement.

Even if demand slowly improves, truckers could be stuck with low shipping prices for quite a while. "We think weaker pricing will pressure margins for the next few quarters," Credit Suisse (CS) analyst Christopher Ceraso warned.

But transportation stocks often rebound at the same time as—and often before—the economy recovers. If the recession is near an end, this could be a great opportunity for investors.

Improvement in demand at J.B. Hunt is "another indicator that business conditions are bottoming," said Robert W. Baird analyst Jon Langenfeld, "which is historically the time to buy the transports."

But it's a tricky time for optimistic investors. The economy's decline has slowed and maybe even stopped, for now. But the latest economic data and earnings releases suggest a full-blown recovery is not yet in sight. For the industrial sector, the hoped-for revival remains on hold.

Steverman is a reporter for BusinessWeek's Investing channel.

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