Wednesday, April 22, 2009

The Road to Recovery? Let's See What the Old School Companies Have to Say

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I'm pressed for time nowadays, so I thought from time to time I'd bring on some guest bloggers who have similar (but not identical) thought processes to myself so that the content is keeping with our general theme, but I can begin to sleep for more than 3 hours a night. Earnings season is especially tough since there is so much information to assimilate in a short period of time. As I wrote coming into the week, I take what the companies are reporting (not "versus analysts expectations" but in a vacuum, quarter over quarter and year over year) as a much more important signal than any government report; most of which are highly flawed.

Tuesday brought many industrial type of companies which should be the seeds of "early cycle recovery". Long time reader Michael Brisky was good enough to take a look at 4 companies I have been keeping my eye on and wrote the piece below - we have a great cross section of the real economy as it covers chemicals, railroads, a general industrial and the largest producer of construction equipment on the planet. As an aside Dupont and UTX have had beautiful charts in this rally - textbook gorgeous in fact. Let's see what these 4 say about the green shoots. Thanks Michael for a great post and if you enjoy this post please check out his blog.

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My name is Michael Brisky, and I'm one of Mark's loyal readers/followers. I share many of his sentiments on the market and economy. You can find more of my thoughts on my blog @ http://www.briskycapital.blogspot.com/

The market has seen a strong rally for the past six weeks. This has nearly everyone wondering if the economy is due for a comeback. As the stock market is often cited as a forward-looking indicator, might the economy have bottomed? Lets take a look at some old school U.S. stocks for some indication. These companies all announced earnings within the past day or two. I'm going to look at United Technologies, Caterpillar Inc., Dupont, and Norfolk Southern.


United Technologies (UTX) is very diversified in the industrial and military sectors. Think Otis Elevators, Carrier HVAC, as well as Pratt & Whitney Aerospace and Sikorsky Helecopter. With this global reach, they should be able to give us a good indication of economic conditions out there:

  • United Technologies Corp. said Tuesday its first-quarter profit fell 28 percent, as frail construction markets dragged down orders for its Otis elevators and Carrier heating and ventilation systems.
  • For the quarter, net income attributable to common shareholders fell to $722 million, or 78 cents per share, from $1 billion, or $1.03 per share, in the same period last year. The latest quarter's results include 12 cents per share in restructuring costs and a tax benefit of 3 cents per share. Revenue fell to $12.2 billion from $14 billion. Analysts surveyed by Thomson Reuters expected earnings of 78 cents per share.

As most of you know, its not so much about the numbers, but what they did relative to expectations. In this case, UTX did well enough, and the market liked it (at least today). They also reaffirmed guidance for FY 2009, which is rare in this market. To give you an idea how much expectations have been lowered in this market, take a look at this quote from Analyst Rick Whittington, "This would have been the quarter the wheels are falling off the bus and it didn't." "It's not a spectacular report. The Carrier and Otis order reports are weak, yet they're not zero."

  • Conversely, operating profit at Sikorsky jumped 42 percent to $116 million. Results were helped by strong military orders as the Obama administration moves more troops into Afghanistan, increasing the reliance on helicopters for troop movements and other activities.
  • (CFO) Hayes said that although order rates continue to be down, they are stabilizing, particularly in China, which is starting to see some benefits from a stimulus program equal to $586 billion.
Pretty solid stuff from UTX. And good news on China.


Caterpillar's (CAT) results, however, were a little different:

  • Heavy equipment maker Caterpillar Inc. reported its first quarterly loss in 17 years on Tuesday, hurt by plunging sales and the cost of laying off thousands of workers. It also said the Obama administration should have allocated more money for roads, bridges and other public works under its stimulus plans.
  • The $112 million loss highlighted the depth and breadth of a global downturn, as the company suffered double-digit sales declines in most of its businesses. Caterpillar's vast geographic reach and array of products -- including black-and-yellow bulldozers, engines for cargo ships and mining trucks that haul materials like iron ore -- make it a bellwether of the global economy.
  • In the first quarter, the Peoria, Ill.-based company posted a loss of $112 million, or 19 cents per share, versus net income of $922 million, or $1.45 per share, a year earlier.
  • Equipment sales dropped 29 percent, led by a 46-percent decline in Europe, Africa and the Middle East. Sales in North America plunged 30 percent while Latin America fell 16 percent. However, sales in the Asia-Pacific region slipped just 2 percent.

This isn't that surprising as construction and mining projects are some of the first to be put on hold when there is economic uncertainty. CAT was one of the first companies to start issuing profit warnings if you think back a few quarters. So they may be the best indicator for when the cycle turns. But look at Asia! More signs of positivity about the Chinese Stimulus.


On to Dupont (DD). Dupont is strong into chemicals, building components, and agriculture. Its one of those companies with a lot of moving parts you sometimes wish you could own just part of, instead of the whole thing. Here's their quarterly results:
  • Citing a sharp drop in global industrial demand that resulted in a 59 percent decline in first-quarter profit, chemical maker DuPont Co. said Tuesday it is boosting efforts to cut costs and developing additional restructuring plans. The Wilmington-based company also pared its full-year outlook, saying it expects volumes to continue to decline in the coming months, but not as steeply as they did in the first quarter. "It's just a very volatile environment," Chief Executive Ellen Kullman said.
  • DuPont reported earnings of $488 million, or 54 cents per share, for the first quarter, down from $1.19 billion, or $1.31 per share, a year ago. Total revenue fell 17 percent to $7.27 billion from $8.77 billion a year ago as DuPont saw a drop in demand for its products in the construction and auto sectors, as well as declines in consumer spending on items such as electronic goods. Analysts expected a profit of 52 cents per share on revenue of $7.74 billion.
  • The company cut its full-year earnings outlook to a range of $1.70 to $2.10 per share, from a previous forecast for profit of $2 to $2.50 per share. Analysts expect earnings of $1.88 per share, on average. "This is the fourth time they've cut guidance in six months," said Ed Yang, an analyst with Oppenheimer & Co. who has an "Underperform" rating on DuPont. "That tells me that it's a very uncertain environment and the fundamentals are extremely weak."
Dupont has some great businesses, but they are all getting hit hard right now. Their exposure to construction (for example Tyvek Homewrap and Corian Countertops), as well as autos (plastics) are especially tough. Barron's Bob O'Brien also wrote briefly about Dupont:

"Dupont has long been considered one of the classic early-cyclical bellwethers for the global economy. If conditions start to get better - in the auto business, electronics, farm economies - it’s going to show up on DuPont’s books before it shows up in the industrial production data the government puts out."


With all of these companies' results, revenue is an important statistic, more so than in other markets. There is a lot of restructuring going on which can have an effect on quarterly earnings, but top line revenue is what it is.

The quarterly revenue stats for these companies YOY:

  • UTX down 15%
  • CAT down 22%
  • DD down 17%
  • NSC down 22%

Also if you get the chance, take a look at the attached presentation. It is about Dupont's businesses in China, and their outlook for the future.

Finally, lets look at Norfolk Southern (NSC), who announced earnings Tuesday:
  • Norfolk Southern Corp., the largest rail carrier of metals and automotive products in North America, said Tuesday its first-quarter earnings tumbled 39 percent as lower costs could not offset plunging shipping demand.
  • The Norfolk, Va.-based company said Tuesday it earned $177 million, or 47 cents per share, compared with $291 million, or 76 cents per share a year earlier.
  • Thomson Reuters says analysts expected profit of 54 cents per share on revenue of $2.04 billion.

Its easy to see how their demand slowed. Metals and automotive products. Competitor CSX reported last week with slightly better results, but the overall trend is the same. Railroads were hot last year when energy prices spiked. I do believe high future energy prices could be a bullish catalyst for this sector, but regular old demand is much more important.

There has been talk of rails benefiting from the Stimulus Plan, but I'm not sure. More likely is money for high-speed rails between major cities. This wouldn't have much effect on a company like NSC.

My Outlook: Despite the recent rally in the stock market, there is a lot of short term pressure on these companies, as well as the entire economy. They are all scrambling to cut costs to stay competitive. Long term, they are companies that can adapt and continue to thrive. Caterpillar and Dupont should have the most upside for investors as they deal with early-cycle products whose market is likely to respond before the broad economy. United Technologies is a combination of both growth and defense which makes it a solid choice for any portfolio. Norfolk Southern will also be a good global growth play once that trade is back on.Based on the results of these companies, I think the economy still has a ways until we see positive growth. The current rally can continue, but is mostly being driven by speculation in oversold stocks instead of improving fundamentals. Until employment numbers stabilize, we're not going to see much strength in the economy.

But keep an eye on China. One of the big takeaways here is what these companies said this week. Look at the confidence they have in the Chinese Stimulus Plan versus the U.S. Stimulus Plan. It may be a bit of wishful thinking, but these companies and many others are looking for China to pull us out of this recession. We have interesting times ahead.

Thanks for reading!

Author has no positions in stocks mentioned.


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