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Things Fall Apart, Even in Industrials

Wear, tear, and competition will drive a comeback in this sector.

Philip Guziec, 12/28/2010

This article first appeared in the December 2010/January 2011 issue of Morningstar Advisor magazine. Get your free subscription here.

The third quarter of 2010 was good for industrials, and looking out a bit further, our analysts are still optimistic about industrial demand. In November, I sat down with some of Morningstar's industrials team to discuss the reasons for their optimism.

Q: What kind of operating performance are we seeing in the industrials at this point in the economic recovery, and what's the outlook for the next year and going forward?

Adam Fleck: So far, in the general industrial space, the outlook has been the strongest in emerging economies, like those in Latin America and China; that's not too surprising. We've seen some good bounce-back in a number of industries that were beaten down severely last year here in North America. Europe has generally seen a weaker recovery, but areas like Germany are probably a little bit stronger, as we've heard from companies like 3M MMM. Eastern Europe and Russia particularly continue to suffer.

Q: How about across categories of industrials? Where are we seeing strength, and where are we seeing weakness?

Fleck: We're seeing strength in heavy equipment, particularly again in emerging economies and even here in North America. We've also seen a pretty good pickup in farm equipment--the farm income numbers here in North America are looking pretty good. Shortages of wheat due to drought in Russia and the fact that the crop yields here in the U.S. are down are both pushing up prices of crops. These are key inputs that should lead to increased purchase activity this year and especially next year.

Daniel Holland: One thing I'd add is that we're seeing a normal behavior in a recovery. A couple of quarters ago, we started seeing the shorter-cycle end-markets improve with more of the consumable products. Now we're starting to see more of the capital- intensive goods come into favor, with order growth rates getting back into double digits. For example, in the automation and control environment, companies are actually spending money to improve their own infrastructure. This is a normal cadence to how the industrials swing back into things.

The other element that I'd add is that while Europe is not necessarily as strong as the other markets, it's nowhere near as bad as what folks were predicting in May/June of last year when you had the Greece crisis. At that point many people thought that Europe was going down and taking the rest of the world with it. Europe's OK. It's not great, but it's manageable, and a lot of companies are OK in an environment where they can plan for a single-digit-growth or no-growth environment.

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