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What to Expect From the Manufacturing Sector This Earnings Season

By Lee Samaha - Jan 21, 2020 at 6:44AM

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MSC Industrial's earnings suggest it's going to be a difficult quarter for manufacturing companies.

With earnings season just around the corner, investors are studying the companies that report early, hoping to get a sense of things to come. One such company is MSC Industrial Direct (MSM -2.82%). Because it's an industrial supply company with short sales cycles, its revenue is always going to be closely tied to current conditions in manufacturing, so let's take a look at what its earnings said about what to expect.

A crystal ball.

Image source: Getty Images.

Expect uncertainty

There are four key takeaways for the industrial sector from MSC's earnings presentations:

  • The first quarter is likely to be a weak one, and the trend downwards is likely to continue.
  • For timing reasons, December was an unusual month for manufacturing companies, and as a result some may find it hard to ascertain a trend in their sales.
  • The industrial sector is experiencing broad-based weakness, with particular softness in the usual suspects like automotive, heavy truck, and agriculture.
  • Aerospace remains "relatively strong" according to CEO Erik Gershwind on the earnings call, but the suspension of Boeing (BA -4.95%) 737 MAX production could have a negative impact.

Weak trends

Frankly, it's no secret that the manufacturing sector will be weak in the first half. Indeed, the best bullish case for the industrial sector in 2020 is built on the idea that the second half will start to see sales trends turning upward while valuations of some stocks in the sector are favorable. 

Of course, if you buy into this thesis, you have to be prepared for some potentially negative news in the near term. For example, here's a look at MSC's monthly average daily sales (ADS) growth. Moreover, management's guidance is for ADS to decline by 1.5% to 3.5% in the first quarter, with January and February down 2.9% on average.

MSC Industrial average daily sales growth

Data source: MSC Industrial Direct. YOY = year over year.

Earnings guidance could be mixed

The environment is getting worse in the near term, and unfortunately the optics on the first quarter could be murky. One issue that could complicate guidance for many companies comes from the fact that Christmas and New Year fell on Wednesdays. This led to MSC's having one fewer sales day in December and "acute softness" in sales in the last two weeks, according to Gershwind.

These factors are likely to lead to some confusion as to the true strength of many industrial companies in December, so look out for some varied commentary on business trends exiting the quarter.

Automotive, trucking, agriculture, and oil and gas will be weak spots

All of these industries have experienced weakness in the second half of 2019, and that looks likely to persist at least into the first half of 2020. Gershwind called them out as being acutely weak, so investors can look forward to a slew of negative commentary on these industries in the coming earnings season.

First signs of weakness in aerospace

One of the few bright spots in the industrial sector in 2019, the aerospace sector has been one of the "go-to" areas of investment in the last year or so. Many of the best manufacturing stocks in 2019 were in this sector (defense was also strong). 

That said, the decision to halt production of the 737 MAX while Boeing waits for approval for its return to service looks likely to hit some companies in the first quarter. It's important to distinguish between the aftermarket and original equipment manufacturer (OEM) in aerospace -- it's companies exposed to the latter that are likely to be affected. Aftermarket companies might actually see some benefit as airlines make plans to use older aircraft more while they wait for the 737 MAX to return to service.

What it all means for investors

Based on MSC Industrial's earnings report and guidance, investors in the sector should brace themselves for some disappointing commentary on first-quarter trading, with much of it coming from automotive, trucking, and heavy industries in general, and possibly some coming from aerospace, too.

True believers in the second-half recovery thesis will use any negative reaction as an opportunity to buy into the stocks in the affected sectors, while the doubters may well sell out.

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Stocks Mentioned

The Boeing Company Stock Quote
The Boeing Company
$125.52 (-4.95%) $-6.53
MSC Industrial Direct Co., Inc. Stock Quote
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*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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