[Ikhqgvas]

Calling a bottom for U.S. industrials? Not so fast
Sun Feb 22, 2009 1:31pm EST
By Nick Zieminski and Scott Malone

CHICAGO (Reuters) - Are industrial sector CEOs in denial about the severity of the economic downturn, or are they just trying to let Wall Street down easy?

Even as the United States has slipped into its deepest recession in decades and demand has fallen off in emerging markets, manufacturing executives say they do not expect customers to back out of big orders agreed to in better times.

Many companies -- including United Technologies Corp (UTX.N: Quote, Profile, Research, Stock Buzz) and Honeywell International Inc (HON.N: Quote, Profile, Research, Stock Buzz) -- have told investors to brace for the possibility of lower profits, and stock analysts have cut their 2009 earnings forecasts by about a third since the financial crisis escalated in October.

Manufacturers are by no means denying there is a problem. Companies including Caterpillar Inc (CAT.N: Quote, Profile, Research, Stock Buzz) and Emerson Electric Co (EMR.N: Quote, Profile, Research, Stock Buzz) have slashed tens of thousands of jobs from their payrolls as they scramble to cut costs.

Even so, sector executives may be overly optimistic in their assumptions about commercial construction holding up and margins improving as raw material prices retreat.

"Anybody who holds on to believing that 2009 is the bottom is dreaming," said Nick Heymann, director of global industrial infrastructure at Sterne Agee in New York. "2009 is the free-fall year. Manufacturing is not going to come back until consumer durable spending comes back."

FORGING AHEAD

The 2009 Reuters Manufacturing and Transportation Summit, being held in Chicago February 23-25, will delve into prospects for the sector.

Reuters has invited a group of manufacturing CEOs to give their views on managing through the downturn, investing for eventual future growth, and how to maximize sales from relatively stable sources, like service and parts.

While companies including Tyco International Ltd (TYC.N: Quote, Profile, Research, Stock Buzz), and Parker Hannifin Corp (PH.N: Quote, Profile, Research, Stock Buzz), managed to close out 2008 with numbers that were better than Wall Street expected, that offered little solace to embattled investors.

There is skepticism on Wall Street that profit forecasts rely on demand rebounding in the second half, driven by the Obama Administration's recently passed $787 billion stimulus, low interest rates and easing oil prices.

"The historical pattern is to start off optimistic and gradually talk the Street down," said Steven Winoker, senior research analyst with Sanford C. Bernstein & Co. "There's been pressure to not be too pessimistic."

GRIM FUNDAMENTALS

The global recession in manufacturing looks to be deepest and longest since 1973-74, with production falling 9.2 percent this year after a 2.5-percent decline in 2008, according to a forecast by the Manufacturers Alliance/MAPI.

The S&P index of industrial stocks is down about 20 percent year-to-date, lagging the broader market by a large margin.

Some markets may not bottom until 2012 or 2013. Among the earliest to recover will be energy-related markets like mining, power generation and water, Sterne Agee predicts. Construction will lag, with the nonresidential part of that market in freefall this year, while sales of factory automation systems or manufacturing equipment could face several lean years amid slashed capital spending.

Since many industrial companies are highly cyclical, prospects cannot improve until credit and liquidity return and economic growth picks up, Bernstein's Winoker said.

For now, he expects companies to stress that their balance sheets are strong and highlight any opportunities to invest in areas that can drive growth later on. These include mergers and acquisitions, new research and development, and upgrading their talent pool, especially in emerging markets like China.

"In bad times, companies with a strong balance sheet and cash flow can pick up the best sales folks and can actually build up infrastructure that was either prohibitively expensive before or just unavailable," Winoker said.

Some pockets of strength exist. Security or fire protection equipment, for example, has to be maintained to meet regulatory standards, and may be partly protected from the downturn. So are defense-related sales, where long-term contracts leave suppliers in good shape for the near term.

Also key to the near-term outlook is companies' ability to generate recurring revenue from service and parts. Such sales are more stable than equipment sales, and in some cases have held up well, as in Tyco's ADT security monitoring business.

Ultimately, industrials' outlook depends on many of the same forces that are driving other sectors: how, and how quickly, the financial system can restore confidence, rebuild its capital base and bring back the liquidity that drives spending on capital goods.

"What has hit everybody is the magnitude of the difficulty, which has been exacerbated by the credit market," said Longbow Research analyst Eli Lustgarten. "That is the linchpin of investment, if we don't solve that we don't get out of this very easily."

(Reporting by Nick Zieminski, editing by Maureen Bavdek)