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Improvement in industrial demand would be a welcome sign for all investors. Even though the U.S. consumer and overall consumer spending are more important for the stock market, industrial companies still matter—a lot—so investors should pay attention to industrial earnings reports.
The industrial economy has been shrinking. U.S. stocks are still moving higher partly because consumers keep spending. Many of them, though, work for industrial businesses. No one wants to see industrial weakness turn into a consumer problem.
Key U.S. manufacturing indexes have come in below 50—indicating contraction—for three months. What’s more, German and Chinese manufacturing activity is down this year. In fact, industrial companies have been talking about slowing demand and trade-war headwinds for more than a year. That span, however, is about how long industrial downturns typically last. Wall Street realizes that and analysts are looking for signs of an upturn.
“While still facing challenging end markets in [the third quarter], Sector Perform-rated Gates saw pockets of stabilization in the quarter,” RBC analyst Deane Dray wrote in a Wednesday research report. Sector perform is the equivalent of Hold. Dray’s price target for Gates’ stock is $13. Gates reported earnings after the close of trading Tuesday and shares jumped almost 8% on Wednesday.
The company is a pure “short-cycle” industrial, according to Dray. That means Gates sells a lot of relatively low-price parts that go into much larger, more-expensive capital equipment. For Gates, that is a lot of belts and hoses for cars and heavy machinery. Wall Street always tracks “short-cycle” companies to help call inflections in demand.
“Auto destocking appears to be showing sign of stabilization,” Citigroup analyst Andrew Kaplowitz said of Gates quarterly performance, in a Wednesday research report. “Although industrial destocking is still seeking a bottom as headwinds from end markets including agriculture, construction and general industrial weighed on results—sales in each down greater than 10%.” Destocking refers to inventory reduction at Gates customers. Purchasing managers won’t reorder stock when they see end market demand falling.
Even though some end markets haven’t turned, Kaplowitz recommends buying shares now. He as a Buy rating and a $14 price target for shares.
It isn’t all good news for industrial investors. Raymond James analyst Sam Darkatsh downgraded another short-cycle industrial Thursday morning. The analyst cut his rating on MSC Industrial Direct (MSM)—a distributor of cutting tools and other products—to Sell from the equivalent of Hold. He doesn’t have a target price for shares.
Darkatsh just doesn’t see the economic environment improving. “There’s simply too much evidence of end market deterioration,” he wrote in a Thursday research report. He points out that metal working activity indexes—like the broader industrial data—are falling.
The conflicting views shouldn’t alarm investors. It isn’t uncommon for analysts to disagree at the bottom or the top of business cycles. After all, calling inflections is hard. Some wait for evidence and others go out on a limb.