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Earnings Will Be Ugly, But Look for This Surprise

Earnings Will Be Ugly, But Look for This Surprise

Saturday, 18 July, 2020 - 06:15

Earnings season is upon us once again, and it’s going to be a particularly ugly one for manufacturers.

While recent data offer reason to believe the pain from pandemic-related lockdowns moderated significantly in June, the sector is still likely to see some of the worst profit and sales declines since the throes of the financial crisis. The key question for industrial companies, as with pretty much everything else, is where do we go from here? Those who have reported so far — including industrial distributor Fastenal Co., trucker J.B. Hunt Transport Services Inc. and railroad Kansas City Southern — remain wary of giving guidance on future demand. “The near-term outlook remains difficult to project. The reopening of industry is occurring in fits and starts as customers reconstitute their workforces and their supply chains,” Fastenal Chief Financial Officer Holden Lewis said on the company’s earnings call. “I would characterize the tone in the field to be one of cautious optimism.”

Unfortunately, the world around us is also providing plenty of fresh sources of pessimism. A surge in coronavirus cases across the US Sun Belt has undercut a fledgling recovery in aerospace and spurred warnings of renewed automotive-plant shutdowns in Michigan. JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. collectively set aside more than $25 billion in the second quarter to cover souring loans, with the CEOs of each bank warning the worst of the pandemic recession was yet to come.

The best guide for investors of where things are headed in manufacturing specifically may be CEOs’ willingness to bet on themselves and their stock prices through a resumption of share buybacks. Many companies shelved scheduled repurchases after the first quarter as volatility ripped through the stock and bond markets and management turned its attention to the more basic problems of making sure parts went where they were needed and employees were safe and sound. It also just wasn’t a great look in the middle of a pandemic. Those uncertainties haven’t gone away, but whatever shape you think a recovery might take — V, W, reverse square root, Nike swoosh — CEOs are flying less blind than they were in March and April. Meanwhile, the Federal Reserve’s bond-buying binge has eliminated concerns about access to funding for all but the most indebted companies. That could open the door to a number of manufacturers announcing plans to restart share buybacks when they report earnings over the next few weeks.

Already, Johnson Controls International Plc announced last month that it would resume buybacks in the current quarter. The repurchase plan is tied to proceeds from the $13.2 billion sale of its car battery business to Brookfield Asset Management last year. Earlier this month, ABB Ltd. said it would launch a share repurchase program with the more than $7.5 billion in proceeds from the completed divestiture of its power-grids business that could ultimately see it reduce its share capital by 10%. Barclays Plc analyst Julian Mitchell sees Dover Corp., Eaton Corp., Honeywell International Inc., Lennox International Inc., Rockwell Automation Inc. and Trane Technologies Plc as among the companies with the most potential to follow suit with resumed or increased buyback programs as early as the current quarter.

Eaton CEO Craig Arnold was one of the few leaders bold enough to talk about share buybacks in the dark days of April. M&A and share repurchases are “absolutely still on the table for us,” Arnold said on the company’s first-quarter earnings call. “We generate a lot of free cash flow in periods of economic weakness.” Like ABB and Johnson Controls, Eaton is also expecting an influx of cash from a major divestiture: The company is aiming to close the $3.3 billion sale of its hydraulics business by the end of this year. Honeywell’s pristine balance sheet stands out, particularly among companies with exposure to the downtrodden aerospace sector. It could spend $1.5 billion on buybacks in the second half of 2020, Mitchell wrote in a report last week.

It remains to be seen what the public reaction is to any resumption of share buybacks, which have increasingly become a political target. The companies on Mitchell’s list have generally been more surgical in their cost-cutting in response to the pandemic, with any job cuts that have been announced paling in comparison to the large waves of layoffs seen at the likes of Boeing Co. and General Electric Co. But it’s an awkward balance, and companies need to be particularly careful in the current environment to avoid the perception of prioritizing shareholder returns over employee welfare and the greater good of the country. Along those lines, Fastenal remains a standout example of the right way to manage the current crisis. In April, I wrote about how Fastenal’s supply-chain management skills allowed the company to respond quickly to the surge in demand for protective gear. Continuing to meet that need for customers meant intentionally taking a bigger margin hit in the second quarter. “Our task in the quarter was getting product to market quickly,” Fastenal CEO Dan Florness said this week on the earnings call. “Sometimes that meant flying product that should be on a ship, sometimes that meant using third-party transportation to move it in a different fashion. It’s not an inexpensive proposition, but it brought the product to market quickly and that was more important.” Fastenal did see a 9.4% drop in a measure of labor expenses relative to a year earlier, largely through a reduction in part-time jobs and hours worked.

The sector remains a world unto itself when it comes to coronavirus pain, and all signs point to a downbeat tone on earnings calls as a nascent rebound in domestic travel fizzles out. Delta Air Lines Inc. was the first of the major US carrier to report second-quarter results, saying this week that it would add back only half as many flights in August as it had originally planned. One optimistic way of looking at this is that even in this time of crisis, airlines haven't totally forsaken their recently discovered discipline on capacity expansions and are taking a more realistic approach to market dynamics than in the past. CEO Ed Bastian expressed optimism that wide-scale layoffs could be avoided after some 17,000 employees took early retirement or voluntary leave options, but his competitors were less optimistic. Southwest Airlines Co. CEO Gary Kelly said this week that the company needs passenger volumes to triple by the end of the year to avoid the first involuntary job cuts in its history. American Airlines Group Inc. and United Airlines Holdings Inc. have sent notices to a combined 61,000 employees warning them that their jobs are at risk once restrictions tied to US aid expire in September, adding pressure on Congress for a fresh round of bailouts.

Speaking of bailouts, Virgin Atlantic Airways Ltd. finally secured a 1.2 billion-pound ($1.5 billion) rescue package. The funding relief was made possible by US hedge fund Davidson Kempner Capital Management; the proceeds from founder Richard Branson’s sale of interests in Virgin Galactic Holdings Inc.; and, as my colleague Chris Bryant notes, the cash advances from grounded customers that the airline has been excruciatingly slow to return. (As a disclosure, I myself am still waiting for a refund from Virgin some three months after a scrapped flight.) Customers may continue to be a key helping hand for airlines. United’s ability to use its frequent-flier program to backstop its $6.8 billion debt sale last month provides a blueprint for future fundraising efforts from rivals, people familiar with the matter told Bloomberg News.

Alfa Laval AB agreed to buy Finnish valve maker Neles Oyj for about $2 billion. The Swedish industrial conglomerate has been planning the purchase for a year and accelerated negotiations after factory-machinery company Valmet Oyj built a stake in Neles, Alfa Laval CEO Tom Erixon said on a call to discuss the bid, according to Bloomberg News. Valmet appears less than pleased with this turn of events and responded by rejecting the bid and increasing its stake in Neles to 15.5%. Alfa Laval can still effectively complete the takeover without Valmet’s permission: It needs at least two-thirds of Neles shareholders to tender their shares. Bank of America analysts said the deal is a good strategic fit for Alfa Laval, while Anssi Raussi of OP Group tells Bloomberg News that Valmet is unlikely to see much in the way of synergies to justify topping Alfa Laval’s already high bid. Even so, Neles is trading above the 11.50 euro offer indicating that at least some shareholders expect a competing offer, or for Alfa Laval to raise its bid to ensure Valmet’s cooperation.

Uber Technologies Inc. is in talks with investors for a $500 million funding round for its freight unit that would value the division at about $4 billion, a person familiar with the matter told Bloomberg News’s Gillian Tan and Lizette Chapman. The freight business — which connects truck drivers with shippers through an online platform — operates as a standalone subsidiary and lost $64 million in the first quarter, more than double its losses from a year earlier. The Wall Street Journal had reported in May that Uber was re-evaluating the business in light of the pandemic. Separately, Uber said this week it would buy Routematch Software Inc., which sells software to public-transit agencies to help them manage payments, dispatching and accommodations for wheelchairs and other special needs.

Hazmat Suits. Way back in February, I mentioned in this newsletter one man’s efforts to protect himself from the coronavirus with a wearable plastic tent. At the time, it was somewhat humorous. But now, with face masks ubiquitous and required for air travel, at least some people think he was on to something. Protective-gear company VYZR Technologies has launched the BioVYZR, a helmet-like contraption that mimics the top half of an astronaut suit and features anti-fogging “windows” and a lithium-battery operated built-in air purifier. This could be yours for $250. I wouldn’t recommend trying to get this thing on a plane, though. The BioVYZR dampens outside sound, which may affect the ability of travelers to hear in-flight safety announcements. A representative for EasyJet Plc told the Telegraph that the suit wouldn’t be allowed in-flight because it would prevent passengers from affixing oxygen masks in a timely fashion, while Ryanair Holdings Plc says the covering is too big and might impede exits.


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