MEDIUM RISK for entreprises
While the sector may be past its peak, we expect to still see good growth in an environment that is supportive for machinery demand. With 2019 GDP growth of 3%, according to our forecast, and PMIs still in expansion mode in the most important regions, we expect sustained order book growth. Order flow still indicates good activity, even though the average book to bill ratio for the major global companies has slipped below 1.0 at the end of 2018. That being said, geopolitics and slowing global economic growth make for a mixed outlook. 2019 will be characterized by increased divergence between sectors and regions. Structural trends such as automation should continue to support the sector.
We still expect a strong outlook for the US, albeit not across the board. US PMIs show the highest level globally, with 52 compared to 49 in China (Q1 19, source/ Bloomberg) and 50.2 in Europe, a region at high risk of slowdown. We expect German machinery to be particularly affected by slowing activity in China. Sentiment indices in China are heading towards the 50 levels.
We continue to expect growth in most end markets, particularly industrial sectors, while consumer sectors are slowing. Construction should see sustained demand as evidenced by continuously rising confidence and activity levels in Q1. We expect strong demand from the mining sector on the back of replacement of an old park, as evidenced by 11% y/y capex growth for the sector (source: company data and Bloomberg consensus). Commodity prices and interest rates are of course a factor of risk to this outlook. We also expect sustained growth in energy, driven by supportive oil prices, continued expansion of US production, which should drive 8% y/y capex growth (source: company data/Bloomberg) and further build out of clean energy. The more challenging sectors are automotive and agricultural equipment. Slowdown in the automotive sector is a major negative driver for machinery demand. A number of machinery companies have quoted automotive weakness in their outlook for the year. Agricultural equipment will see a negative impact from protectionism. This is being reflected in declining confidence indices, particularly in the US, where the agricultural confidence index declined to 109 at the end of 2018, down 4pts y/y.
A continued feature, rising input costs will weigh on margins, particularly commodities (with the exception of steel) but also labour. We expect an increasing impact, as pricing power is likely to reduce in a more challenging environment. The large companies have seen margins contracting between 20bps and 100bps in Q4 18 on the back of tariffs and cost inflation. Negative earnings revisions, -2.6% over the past three months, indicate weakening sentiment on profitability. That being said, as a whole the sector is still expected to deliver 21% y/y earnings growth across the board and 8.5% for its largest constituents (source: Bloomberg and EH). But we do expect variation around the average.
The sector is standing on solid financials with an average net debt/Ebitda ratio of 2.0x at the end of 2018 (source/ company data, Bloomberg). That should in aggregate allow it to weather weak cash conversion: Supply chain bottlenecks have raised working capital requirements in the sector, which has led to reduced cash generation. However, we do point out that there are large differentials across the sector as far as ability to absorb such issues is concerned
Global trade relations will be a key determinant for the sector. Our base case is for global trade to decelerate over the next two years, despite the possible normalization of trade relations between China and the US. US markets are strong enough so that companies have pricing power and are able to pass on rising raw materials costs resulting from tariffs. We expect that to remain the case. As in other sectors, there is risk of flow diversion away from the US to Europe. This could impact pricing power of European companies and in turn profitability.
Robotics manufacturers: The sector benefits from a secular growth trend in fab automation. Automotive is a strong driver but also electronics and other sectors.
Heavy manufacturing machinery: Continued growth in industrial manufacturing should continue to support sector order books, even though the sector is coming over its peak.
Specialised technologies: Global economic activity along with recovery in mining and structural demand related to clean energy and sustainable manufacturing underpins activity.
Contact Euler Hermes
Economic Research Team
Sector Risk Analyst