Manufacturing recovery is a slow game of inches

Industrial Strength
Bloomberg

Happy Friday! Next week is the 100th edition of this newsletter – time flies when you're having fun – so it's a good time to take stock. When I started this, readers had asked for a comprehensive roundup of the week's industrial news. Is that still helpful, or would you prefer I was more selective? Are there any areas you'd like to see more on? What about timing? I may not be able to make everyone happy (and bear in mind I'm just one person with other responsibilities), but this newsletter exists for you and I want to make sure people are getting the most out of it. So please email me at bsutherland7@bloomberg.net and let me know. Thank you as always for reading and have a great weekend!

Industrial companies, they're just like us! That is to say, they're stuck between cautious optimism that the worst of the coronavirus pandemic is behind us as far as the economy is concerned and a mountain of worry about the unpredictable future. 

After a slew of updates in the past two weeks, it's clear the manufacturing economy has stabilized. But the recovery is a game of inches, to borrow a favorite phrase from General Electric Co. CEO Larry Culp. U.S. factory output rose in August by less than economists had forecast and at a slower pace than the month before, data from the Federal Reserve showed this week. Total capacity utilization (including mines and utilities) is hovering around 71%, compared with a pre-pandemic range of about 77%, the data show. If manufacturers aren't using all the factory equipment they already have, they're unlikely to shell out precious capital for new investments.

At the company level, updates from 3M Co. and Caterpillar Inc. this week indicated sales trends for August were comparable to what those companies saw in July. Guidance for overall sales of $8.2 billion to $8.3 billion in the third quarter at 3M implies little improvement in September, either, although this could be conservative, says Barclays Plc analyst Julian Mitchell. "There is still significant global economic uncertainty, given the pandemic, and so I would say it's prudent for us to remain cautious," 3M CEO Mike Roman said this week in a presentation at a Morgan Stanley conference. Beyond some improvements in health care as people return to hospitals for non-Covid procedures and an uptick in consumer-facing products, "we see our customers generally remaining cautious given that economic uncertainty," he said. That's a lot of caution and uncertainty. 

There are some inklings of hope elsewhere: Dover Corp. is sticking with its 2020 earnings guidance for now, but at an investor day this week, the company laid out why it's now more confident in hitting the top end of the $5- to $5.25-a-share adjusted range. CEO Richard Tobin even hinted at a possible boost to the forecast once the company gets through the rest of the third quarter. Fortive Corp. raised its third-quarter sales outlook earlier this month, saying it now sees a possibility of flat revenue relative to the year-earlier period compared with a previous forecast for at least a 5% decline. Both companies are benefiting from healthy demand for fuel pumps as gas stations work to meet a mandate from the credit-card companies for chip-card compliant machines. (For Fortive, that business is part of the Vontier Corp. spinoff it's planning to complete by Oct. 9.) But that's not the only driver of the rosier outlooks. Dover also highlighted "robust" demand for heat-exchangers, aerospace and defense and biopharmaceutical products, as well as "constructive" conditions in marking and coding, food retail and vehicle maintenance. At the Morgan Stanley conference this week, Fortive CEO Jim Lico called out improvements in sales for the company's Tektronix and Fluke instruments as well as the advanced sterilization products business it purchased last year from Johnson & Johnson. 

Emerson Electric Co. said this week that underlying orders are trending down 11% on average over the trailing three-month period through August. That compares with 15% down as of July and a decline of 19% as of June. Emerson characterized this showing as "expected" and said the numbers fit with the company's guidance for the quarter ending in September. There may be some room for an upside surprise through the commercial and residential division that houses a smorgasbord of products ranging from air-conditioner controls to professional tools and InSinkErator garbage disposals. The division's trailing three-month average orders flipped to the positive as of August amid healthy spending on residential HVAC systems and the continuing boom in anything tied to home improvement. Robust demand for tools in North America is now spreading to Europe and emerging markets as well, Stanley Black & Decker Inc. CEO Jim Loree said at the Morgan Stanley conference. That was a big driver behind the company's decision last month to raise its guidance for second-half organic sales to low- to mid-single digit growth. Just a month earlier, Stanley had predicted sales in the latter part of the year would be flat at best and slump 7.5% at worst. 

In general, the third quarter is unlikely to hold many surprises. Most manufacturers have been fairly diligent about updating investors on monthly trends since the last round of earnings calls in July. So the wild double-digit earnings beats relative to analysts' estimates that were essentially just guesses are likely done for now. But that also means there's not a lot to get excited about in the near term. A recovery is clearly underway, but we're still on the scenic route. 

VINDICATION FOR FRED SMITH
It didn't have much competition amid a pandemic that's crushed most other industrial-linked businesses, but FedEx Corp. is the comeback story of 2020. The package delivery company reported record revenue for the quarter ending in August, and operating margins were up by more than a third in a sign that efforts to capitalize on the pandemic-fueled boom in e-commerce with higher prices are paying off. Free cash flow in the period also hit a record. It took a global pandemic, but all of a sudden years of heavy investment in automated equipment and weekend service and the endless "just trust us" defenses on the part of management finally led to a result that investors can cheer. The question now is how long founder Fred Smith continues to serve as CEO. The FedEx board has repeatedly adjusted the rules on age limits for directors to allow Smith to continue to serve. In an interview with Bloomberg New's Thomas Black last December — just days after FedEx announced the latest in a string of earnings disappointments and guidance cuts — Smith said he wanted to put the company on a better path before retiring. Nearly one year later, FedEx is on much more solid footing and finally receiving the recognition from investors that Smith has long felt was deserved. Smith recommended Chief Operating Officer Raj Subramaniam to succeed him if he retires or is incapacitated but has said it's up to the board to decide whether to keep the chairman and CEO roles combined. 


DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
Women in Rail. Last week we talked about how industrial companies — and specifically railroads — wanted to add more women to their ranks. Well, Warren Buffett's BNSF Railway Co. heard the call and then some. BNSF this week named Kathryn Farmer as CEO, becoming the first of the major North American railroads to tap a woman for the top job. Farmer, who has been at the railroad for nearly 30 years, will take over on Jan. 1; current CEO Carl Ice will remain on the board. It's unclear whether Farmer will bring a new perspective to the precision-scheduled railroading strategy that's taken the industry by storm. BNSF has been the lone holdout on conversion to the operating philosophy, which seeks to limit the cars, people and capital necessary to run a train. Buffett has in the past indicated that's actually been a competitive advantage for BNSF; precision-scheduled railroading forces the customer to make changes to its operations, too, and some have been turned off by service disruptions. 

Bombardier Inc. agreed to shave $350 million off the price of its rail unit, preserving a deal with Alstom SA that will now close sooner than previously expected. Alstom and Bombardier now think they can wrap things up by the first quarter of 2021, pending regulatory approval, compared with a previous timeline for sometime in the first half of 2021. The lower price reflects a downshift in performance for the rail unit since the deal was first reached in February. While that means less cash for the company's sagging balance sheet, that's much better than the alternative of no deal at all. Bombardier bonds and shares both rallied on the news. In other deal renegotiations, Fiat Chrysler Automobiles NV agreed to shrink a dividend payout for its shareholders in the merger with PSA Group by 2.6 billion euros ($3.1 billion) to give the combined company more financial cushion to weather the coronavirus pandemic. To make up for the reduced dividend, Fiat holders will get a stake in French supplier Faurecia SE, and the boards will consider an additional payout down the road. 

Delta Air Lines Inc. followed the example of United Airlines Holdings Inc. with a huge debt sale backed by its customer loyalty program. The company raised $9 billion this week in what Bloomberg News says is the airline industry's largest ever debt deal. Thanks to the fresh cash infusion, Delta says it will no longer need to take out a federal loan. Because so many employees took buyout options and reduced hours, the company says it will also be able to avoid involuntary cuts to its flight attendant and on-ground frontline staff. It will still have too many pilots, but Delta is working with the Air Line Pilots Association on a proposal that would delay furloughs until January and reduce the total number that are needed. In contrast, the layoffs just keep piling up on the manufacturing side of the aerospace world, with Raytheon Technologies Corp. saying this week that it would have to cut 15,000 jobs and rethink some high-cost factories.

Covestro AG has attracted the attention of buyout firm Apollo Global Management Inc., people familiar with the matter tell Bloomberg News. Those people said that Apollo had contacted the German plastics maker in recent weeks, but the company said Friday it wasn't in takeover talks with the private equity firm. Apollo has experience with plastics takeovers and reportedly considered a buyout of the Covestro business before Bayer AG spun it out in 2015. A deal, if it were to happen, would be one of the largest industrial and materials takeovers of the year. Covestro shares climbed 5% on Friday, giving the company a market value of 8.6 billion euros ($10.2 billion). 
 

Navistar International Corp. rejected a $3.6 billion takeover offer from Volkswagen AG's heavy-truck business Traton SE as too low, but it left the door open to continuing talks. Traton's rebuffed $43-a-share offer was already a material increase from its last bid of $35, but Navistar has now agreed to let the would-be buyer do due diligence so that it can "appreciate the true value of a potential combination." Traton already owns a nearly 17% stake in Navistar, falling just behind Carl Icahn on the shareholder register. Elsewhere in the logistics world, Uber Technologies Inc. has agreed to sell its European freight business to Berlin-based startup Sennder. The deal is reportedly valued at about 900 million euros ($1.1 billion), with Uber taking a minority stake in Sennder as part of the transaction. The two companies also agreed to a commercial partnership whereby Sennder will refer customers to Uber for North American service and Uber will do the same for Sennder in Europe. 

BONUS READING
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End of Combustion Engine Moves Closer With EU Climate Plan
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