“When you ask about pricing, you better believe pricing is up.”
– W. Marvin Rush, CEO of Commercial Truck Dealer Rush Enterprises
With shares of ‘gravity assisted’ EV plays and ‘equity sale’ powered fuel cells promotions appropriately trading like hot messes, we’d like to draw your attention to some ‘boring’ names that we expect to crush it in 1H22. The Caterpillars, PACCARs, and Volvos (AB) - real companies with real profits that we added as Best Ideas longs in 2H21 on relative weakness.
We think these machinery names offer an exceptional set-up as supply chain constraints ease, particularly with this quarter’s “Just Right” macro backdrop, peaking inflationary pressures, and improving emerging market outlook.
Machinery names were clobbered after the first quarter of 2021. The group is hardly in favor. Some investors won’t engage without a ‘space farming’ or ‘hydrogen powertrain’ to spice it up. Our quantitative model predicts 54% of readers have already stopped reading this Early Look because we mentioned machinery. Quitters.
Back to the Industrials Grind…
Are markets getting less ‘efficient’ at pricing Industrials? With ETFs, algos, COVID, retail traders, stimulus, and the like, maybe. But the market was never all that good; just look at GE in 2000, URI in 2010, CAT circa 2012, WAB in 2015, or, we think, ROP now.
Cyclicals provide good fishing for alpha generation, plus or minus a quarter or two.
The current operating environment for these manufacturers is unprecedented. Demand is already on the moon and pricing is rocketing, to borrow language from crypto. The US government even passed a sizeable infrastructure bill, adding fuel to a demand fire. Residential construction is strong, commodity-related capital spending is increasing, and truck/equipment fleets are highly utilized and aging.
That’s all excellent…usually.
But supply chain challenges have held back production, deliveries, margins, and revenues. Component shortages amid robust order intake have swelled backlogs, extending the time between order receipt and revenue recognition. Matching production costs with order pricing can be a challenge when lead times stretch, but it currently gives investors visibility into rising prices for these sales.
Supply constraints on production look to be easing. This week’s ISM Manufacturing report showed a sharp decline in its Supplier Deliveries Index to its lowest level in over a year. As declines in that reading translate to manufacturing lines and shop floors, the impact on manufacturing profitability may prove wildly underestimated.
Equipment prices in backlog are up much more than the pricing reflected in the (easy) 2021 compares; higher priced orders have already been taken in recent months. If input costs turn disinflationary and production volumes increases, manufacturers may see margins move sharply higher. We’ll get the confluence of higher production, which lowers unit costs and increases revenue, with some of the most robust pricing we’ve seen in decades.
Of course, little in capital markets is smooth or risk-free. Are customers over-ordering to secure build slots? Perhaps, but long wait times can equally dissuade order activity. Will omicron in China, or an anticipated mid-year growth deceleration preclude outperformance? Maybe, but so much of the backlog is just refilling depleted inventories and meeting existing deficiencies that reports against easy compares would hold up against all but the direst of circumstances…mostly further supply chain disruptions.
Cyclical margins may peak early in this expansion. Longs and shorts alike should carefully gauge the pressure behind easing manufacturing bottlenecks. Machinery has a methuselah of 2022 vintage ‘prestige cuvee alpha’ pent-up waiting a disinflationary cork to pop.
If you would like to learn more about my research team's in-depth investing research please reach out to .
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 1.41-1.77% (bullish)
UST 2yr Yield 0.68-0.89% (bullish)
SPX 4 (bullish)
NASDAQ 15,005-16,154 (bullish)
RUT 2190-2296 (neutral)
Tech (XLK) 167.03-179.11 (bullish)
Consumer Discretionary (XLY) 200-211 (bullish)
Housing (ITB) 78.07-84.01 (bullish)
REITS (XLRE) 49.02-52.60 (bullish)
Oil (WTI) 73.87-80.29 (bullish)
Nat Gas 3.52-4.02 (bearish)
Gold 1 (bullish)
Bitcoin 40,217-49,994 (bearish)
Have a great weekend,
Jay Van Sciver
Industrials analyst
