Industrial demand may finally be slowing
Sales aren’t falling off a cliff, but there are signs that growth has peaked
Is industrial demand still too hot for supply chains to handle, or starting to show signs of slowing down? As a volatile earnings season draws to a close, clarity is in shorter supply than semiconductors.
Most manufacturers are still growing sales on a headline basis, but almost all that momentum in the first quarter came from price increases. Industrial companies say that reflects the extent to which supply-chain challenges continue to thwart their ability to get product out the door. But analysts and investors are increasingly concerned that parts shortages and logistics snarls may be masking — or perhaps exacerbating — the beginnings of a deterioration in underlying demand.
Meanwhile, inflation has gotten worse, crimping margins and forcing companies to push through yet more price increases that at some point will catch up with them if they haven't already. Covid lockdowns in China and Russia's invasion of Ukraine introduced new variables in an industry that definitely didn't need more challenges.
There is no evidence that demand is falling off a cliff: Fastenal Co, a large distributor of factory floor odds and ends based in Winona, Minnesota, said this week that average daily sales in April grew more than 20% compared with a year ago, up from a 19% pace in March. Amid concerns about a consumer slowdown, sales at pool equipment maker Hayward Holdings Inc increased 23% in the first three months of 2022, a gain that was all the more remarkable considering revenue jumped 96% in the year-earlier period. Stanley Black & Decker Inc said it would have shipped $200 million of additional professional power tools in the first quarter if it weren't for continued constraints on electronic component availability. Air conditioner maker Carrier Global Corp anticipates the disruptions to its manufacturing operations in the Shanghai region from Covid lockdowns will cost it $100 million of sales in the second quarter. But the company expects this to be a temporary blip that it will make up for as the year progresses.
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Chip shortages and inflation weighed on results at Rockwell Automation Inc and forced a big cut to its full-year outlook. But the company actually raised its projection for orders to about $10 billion, indicating customers keep buying. Cancellation rates are very low and largely reflect customers who are changing their orders for a different bill of materials rather than walking away, Rockwell Chief Executive Officer Blake Moret said in an interview.
As with most things on Wall Street, however, industrial expansion is a game of "What have you done for me lately?" There are early warning signs that the pace of growth may have peaked and that some pullback is happening. The Institute for Supply Management's gauges of new US factory orders and backlogs released this week indicated decelerating growth in April. Both measures remain in expansion territory but dropped to the lowest levels since 2020.
Copper markets are often seen as a good proxy of industrial demand because the material is used heavily in goods manufacturing. Prices for the metal remain elevated relative to pre-pandemic levels, but they slumped this week to the lowest since December amid concerns that the knock-on effects of monetary tightening and the Covid lockdowns in China may crimp demand.
"Most cycles, as reminder, tend not to have a 'lights out' moment (one reason that the Covid downturn was so exceptional), but are characterized by a slow deterioration," Barclays Plc analyst Julian Mitchell wrote in a report this week.
Meanwhile, seasonally adjusted air-freight volumes fell in March to a 16-month low as the disruptions in China and Russia's invasion of Ukraine slowed trade and manufacturing exports, according to the International Air Transport Association. "The inventory restocking cycle that had started during the initial rebound from the pandemic in late-2020, and that led to businesses turning to air freight to rapidly meet demand, looks to have come to an end," the trade group said this week.
The April update for the Logistics Managers' Index — also released this week — indicated a loosening in transportation capacity and a corresponding tempering of the growth in sky-high freight prices. "For the moment, supply chains are flush with inventory," the report said. This suggests that once companies can finally get products delivered to customers, there may not be much need for a fresh round of ordering and therefore the demand reflected in robust industrial backlogs is as good as it's going to get.
Pool products aside, the home-improvement craze seems to be finally fading: Emerson Electric Co. this week said retail purchases of its tools and other residential products were slowing as inflation made items more expensive and consumers diverted spending to other activities. That echoed some preliminary conservatism from Stanley Black & Decker on the tool sales volume outlook for the rest of the year as it rolls out its fourth major price increase.
In times of economic uncertainty and jittery markets, it's usually helpful to focus on industrial CEOs' actions as a guide, rather than their words. To that end, it isn't encouraging that Kennametal Inc., Emerson and Rockwell are modestly trimming their capital expenditures. But once again supply chains are muddling the picture. Kennametal blamed longer lead times and Covid absenteeism for its pullback. Rockwell cited higher costs as a reason for the $100 million reduction in its planned investment spending, and CEO Moret said difficulties in hiring sufficient workers were also a factor.
Automation equipment is still very much in demand as labour shortages and concerns about far-flung supply chains accelerate investment in factories closer to the end customer and as electric vehicle and semiconductor companies ramp up their capacity. "The volatility is certainly on my mind, as we saw in the results which were below our expectations in the quarter," Moret said. Even so, "you have these multiyear capex investments that have been announced, and I don't expect those to be stopped or delayed. If you think about specifically semiconductor capacity, the world is screaming for more semiconductors."
Investors, however, are focused on the immediate future, rather than the five-year trajectory. They seem to have landed on the side of pessimism about the sustainability of current demand. Rockwell shares, for example, fell 14.5% on its earnings release this week. It's telling that the vast majority of the top-performing industrial stocks this year are defence contractors that will benefit from stepped up spending by the US and Europe in response to Russia's invasion of Ukraine. Such stocks are typically a relative safe haven should a recession occur.
Quote of the week
"The Boeing Company is at its best when it focuses on engineering world-class airplanes with the highest standards of safety. Moving their headquarters to Chicago and away from their roots in the Pacific Northwest was a tragic mistake that took them further from that mission and empowered Wall Street bean-counters over the line engineers who built their once-great reputation. Moving their headquarters again, this time to be closer to the federal regulators and policymakers in Washington, DC is another step in the wrong direction." — Representative Peter DeFazio, an Oregon Democrat and chair of the House Committee on Transportation and Infrastructure.
DeFazio made the comments in response to the news that Boeing Co will move its corporate headquarters to Arlington, Virginia, from Chicago. Unlike most headquarters moves, this one is likely more about cutting costs than opening a glitzy new building.
Boeing has an existing defence campus in Arlington with unused space. But the move still sends a curious message. Headquarters relocations tend to be disruptive in the best of times and Boeing certainly doesn't need any more distractions. The company was lambasted for its decision to move the headquarters to Chicago in 2001 after almost a century in Seattle. Critics contended that the geographical distance between executives and engineers caused Boeing to lose focus on building safe, quality airplanes.
Situating management in DC will put executives closer to customers at the Pentagon and Federal Aviation Administration regulators with whom the company's relationship has been fractured. But it isn't as if Boeing had a negligible lobbying presence in the nation's capital. At best, this rejiggering seems unlikely to do much to remedy Boeing's primary problem of figuring out how to deliver jets as promised to both commercial and military customers. At worst, it suggests management still isn't taking the need for a deeper cultural overhaul seriously enough and is continuing to focus on the wrong things.
Boeing also plans to set up a research and technology hub in Northern Virginia that will focus on cybersecurity, autonomous operations, quantum sciences and software and systems engineering. A shift toward more flexible working policies means Boeing needs less office space, although it will continue to maintain some presence in Chicago, the company said. The commercial aerospace business will continue to be based out of Seattle, Washington, for operational purposes, while the services arm will be in Plano, Texas. It's unclear what will happen to Boeing's tower at 100 North Riverside Plaza in Chicago; while Boeing hasn't been actively marketing the building, officials have indicated they are open to serious offers, a person familiar with the matter told Bloomberg News.
Deals, activists and corporate governance
Spirit Airlines Inc rejected a takeover offer from JetBlue Airways Corp and chose to stick with the lower-price deal it had already agreed to with Frontier Airlines' parent company, saying the latter proposal carries less antitrust risk. Spirit's main point of contention is that JetBlue is pursuing a takeover of the low-cost carrier while simultaneously attempting to defend a marketing alliance with American Airlines Group Inc. that the Justice Department is trying to block. It is indeed a bit of a head-scratcher. A plan to rejigger the layout of Spirit's aircraft to give customers more leg room and improve the target airline's service offerings to be more in line with JetBlue's would result in higher prices for consumers, fewer seats and questionable competitive benefits, Spirit said. But the fact remains that JetBlue was willing to pay a substantially higher price for Spirit than Frontier has offered to date. JetBlue's $33-a-share all-cash offer compares with a stock-and-cash bid from Frontier that's currently valued at about $21 a share. It's surprising that Spirit didn't use the JetBlue offer as leverage to push for a higher price. The board will need to do a better job of explaining that choice. Spirit shares fell more than 15% this week.
Emerson is exploring options to divest Metran, its Russia-based manufacturing subsidiary, amid a global outcry over the country's invasion of Ukraine and broad European and US sanctions in response. The divestiture is proving easier said than done: "Look, I don't want to sell the business to an oligarch. I don't want to sell it to the Russian government," CEO Lal Karsanbhai told Bloomberg News in an interview. "Our preference would be to sell it to our management team and employees in Russia."
The latter path would be modelled after an agreement Schneider Electric SE struck in April to transfer its Russian operations to local leadership. Karsanbhai's comments offer interesting insight into the difficulties companies face in untangling themselves from the country.
Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. A former M&A reporter for Bloomberg News, she writes the Industrial Strength newsletter. @blsuth
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.
