The latest earnings reports from Caterpillar Inc. and 3M Co., two of the world’s leading industrial stocks, indicate that the outlook for the sector is going to get worse before it gets better.
Escalating cost pressures and tariff barriers have started to hit their bottom lines. On October 23, Caterpillar Inc (NYSE:CAT), the powerful mining and construction equipment maker, repeated its warning about rising costs due to higher steel prices and US tariffs.
Caterpillar said in a government filing that the impact of recently imposed tariffs was about $40 million in the third quarter, and the company sees the full year impact of the tariffs at the low-end of the range of $100 million to $200 million.
Investors punished Caterpillar severely after the company failed to raise its guidance for the full year despite modestly better-than-expected third quarter results.
On a similar note, 3M Company (NYSE:MMM), one of the world's largest industrial conglomerates, warned that high material prices have contributed to a decline in sales. The maker of Post-it notes and touch screens cut its 2018 profit forecast to $10 a share. This is the third time this year that the company has trimmed its outlook.
The diminished outlook is the result of weakness in many of the markets where it has a leading position, such as automotive and dental products. Core sales at 3M expanded just 1.3% in the third quarter, falling well short of analysts’ expectations for a gain of 3%.
3M reported that sales fell for the first time in two years, with declines in three of the company’s five main businesses during the third quarter: electronics and energy, health care and consumer products.
Tariffs from the US-China trade war amount to a $100 million headwind for the company, but the company will seek to offset that by raising prices, Chief Financial Officer Nick Gangestad said on the conference call.
Tanking Shares, More Pain in Store
Both 3M and Caterpillar are in a bear market this year, as their share prices plunged more than 20% after peaking in early 2018.
Trading at $115.63, Caterpillar has lost 33% from the 52-week high.
In a similar downtrend, 3M is trading at $184.99, a 29% drop from this year’s high of $259.77.
And the bad news for both of these stocks is that they will likely see further weakness as the Federal Reserve continues with its monetary tightening.
Industrials stocks, such as 3M and Caterpillar, are very sensitive to interest rate moves as their fortunes are closely tied with the economy where demand is rising and interest rates are low. As the Fed tries to cool down the overheated economy, investors usually shun industrial stocks.
In this fast changing economic backdrop, it’s better for investors to avoid front line industrial stocks, such 3M and Caterpillar. Their share price charts suggest that they have seen the peak in the current bull market and their earnings momentum will continue to slow.
Despite this warning regarding these large industrial names, we’re not suggesting that these companies are entering a recession-type demand compression. The point we want to make is that for Caterpillar and 3M the good days of sales growth and profit margins are already behind them. And unfortunately, their future looks even more uncertain.
Bottom Line
As the world’s economic growth falters and uncertainty rises in the US, investors should be very cautious as to which stocks they buy and hold. This is certainly not the right time to get bullish on volatile industrial names which get hammered at the first sign of recession.