The Quarterly. Analyst themes of quarterly industrial products earnings 3Q17. Companies look for increased efficiency, new targets in 3Q17

Transcription

1 The Quarterly Analyst themes of quarterly industrial products earnings 3Q17 An optimistic outlook on growth in the industrial sector continued on many 3Q17 earnings calls. While hurricane activity created supply chain and production challenges for several peers, most companies expressed overall confidence in rising order activity, led by customers in emerging markets. Productivity remains a high priority, with increasing attention turning to supply chains for operational improvement. A heightened focus on the customer remains key to long-term growth. Companies look for increased efficiency, new targets in 3Q17 Welcome to The Quarterly, a review of the top themes discussed by leaders of 21 industrial products sector companies during earnings calls with analysts. The Quarterly tracks the movement of these themes from quarter to quarter to provide a time-based perspective on shifts in the industrial sector landscape. We view the themes in The Quarterly as providing a timely snapshot rather than a universal assessment of importance, revealing insights into the minds of both industrial leaders and sector analysts during the quarter. Themes that stood out in 3Q17 include: Geographic developments, which rose from eighth to second place this quarter. Many peers credited increased demand from emerging markets, particularly China, as boosting both revenues and margins in 3Q. Hurricane activity in North America and the Caribbean affected several peers by disrupting supply chains, closing down and damaging facilities, and reducing demand from customers also recovering from the storms. Critical projects, which returned to the top 10 list this quarter. Projections for large orders and new projects in 4Q17 and 1H18 were increased by several peers, another indication of rising strength in the industrial sector. Infrastructure in emerging markets is continuing to pick up in activity. Aerospace and defense companies experienced challenges in meeting deadlines due to supply constraints, a result of increasing demand from customers. Supply chain management, which rose by one to sixth place. In addition to the constraints affecting A&D peers, rising raw materials prices were cited by chemicals peers in 3Q. Across the sector, industrial companies continue to look for opportunities to reduce costs and improve performance within their supply chains, particularly after acquisitions. Developments in end markets, the leading theme in both 2Q and 3Q. The most successful industrial companies are becoming more customer-focused. An increased concentration on core businesses over the last few years has positioned companies to build strong market presences where growth potential is highest. Jerry Gootee EY Americas Advisory Sector Leader, Industrial Products Page 1

2 Top 10 themes from quarterly earnings calls New 3Q17 1. Developments in end markets 2. Geographic developments 3. Change in financial outlook 4. Working capital and cash flow management 5. Competitive environment 6. Supply chain management 7. Innovation and new product/service launches 8. Cost reduction 9. Critical projects 10. Transaction strategy (future plans) 2Q17 1. Developments in end markets 2. Cost reduction 3. Working capital and cash flow management 4. Business reorganization/restructuring 5. Change in financial outlook 6. Innovation and new product/service launches 7. Supply chain management 8. Geographic developments 9. Competitive environment 10. Transaction strategy (future plans) Key themes 1 Developments in end markets Trends in key customer segments affecting demands for products and services Outlook on broad economic growth and demand for industrial products generally more positive than 2Q Spending by oil and gas customers remains mixed; purchases of large equipment such as gas turbines are still down, though safety equipment is showing signs of recovery Reduced demand from power and utilities, due in part to overcapacity in US electricity generation Demand for specialty plastics, hybrid/electric batteries driven by automotive manufacturing; demand rising more quickly in Asia than in Europe, US Strong growth in air passenger traffic continues to drive demand for commercial aircraft, business jets Industrial companies are once again putting growth at the top of their agendas. Increasing strength in demand from regions such as Asia and Europe, along with continued activity in North America, are lifting revenues. Key customer segments such as automotive, commercial airlines, defense and consumer electronics are driving demand through increased order activity. Many industrial companies are well positioned to benefit from these growth drivers after years of divesting noncore operations and focusing more on pure-play portfolios. Acquisition activity is likely to be shaped by selective largescale deals, followed by strategic spin-offs, as peer groups seek to protect and grow market share. David Gale, Americas Industrial Sector Leader, Transaction Advisory Services, Ernst & Young LLP 2 Geographic developments Changes in market conditions by region Hurricanes in North America and Caribbean cited by one-third of peers for slowdowns in manufacturing, supply chain constraints and reduced order activity by customers Latin America revenues down, particularly for agriculture in Brazil For A&D, demand continues to increase from military customers in Europe, the US and the Middle East China frequently mentioned as one of the strongest growth markets in Asia (and globally); automotive, construction and engineering, and semiconductor markets especially strong Page 2

3 Key themes Value protection continues to be a focus of industrial companies who are battling disruptive and transformative events on all fronts internal and external. Natural disasters have significantly impacted industrial companies this quarter. Notably the disruptions resulting from severe and unprecedented hurricane activity in North America and the Caribbean have companies revisiting their risk management strategy throughout the supply chain ecosystem. Risk management and organizational readiness for future disruptions will be driven by executive-level sponsorship around the following areas: assessing the risk and resiliency of supply chain continuity in the organization, performing end-to-end supply chain risk assessments and executing third-party risk and contingency planning. William Thomas, Advisory Executive Director, Risk, Ernst & Young LLP 3 Change in financial outlook Changing forecasts for revenues or earnings per share More optimistic tone from many leaders in 3Q vs. 2Q based on revenues and order activity exceeding projections Raised outlooks on revenues for A&D companies due to growth in commercial aviation and anticipated increases in orders for defense equipment Success of ongoing productivity programs supporting growth in EBITDA (earnings before interest, taxes, depreciation and amortization), earningsper-share (EPS) forecasts Hurricane impact (facility downtime, supply chain disruptions) cited as a headwind for some peers 4 Working capital and cash flow management Significant changes in working capital and cash flow Increases in positive performance realized from productivity and cost control programs introduced in previous quarters Year-on-year comparisons boosted by portfolio management, especially divestitures of non-core operations Commitments to dividends and share repurchase programs made by many peers; however, reductions made by select peers in enterprise-wide reorganization programs Balancing of capital-heavy investments in long-term growth, such as acquisition integration, against quarter-to-quarter revenue and profit goals As cash balances continue to rise at many peers, interest in acquisitions also rises tempered by an awareness of the risk of overpaying for targets Improved collection of receivables continues to be an area of focus Reallocation of internal talent at one peer to better focus on working capital performance and meeting targets 5 Competitive environment Expanding competitive universe, pressure on pricing Product pricing, technological capabilities and enhanced performance to remain key competitive factors in the industry With digital taking a central stage in the manufacturing ecosystem, the competitive universe to expand beyond IP and include competition from software companies Partnership between two major OEMs on a narrow-body aircraft program expected to change the competitive landscape in commercial aerospace Striking a balance between increasing raw material costs and competitive pricing to be critical for chemicals companies 6 Supply chain management Optimization programs and challenges; increase in inventory Delays in receiving key supplies, such as engines for A&D OEMs, create challenges for delivery schedules and increase inventory A&D companies closely monitor their supply chain on every dimension to ensure the entire supply chain is well prepared to support future ramp-up Supply chain integration and optimizing supply chain footprint likely to result in cost savings for IP peers Rising raw materials costs put pressure on margins for chemicals and industrial manufacturers; one peer described seeking lower-cost alternatives rather than raising product prices The complex process of supply chain optimization involves a number of functions, from adjusting production footprints and capacity to maximizing the benefits of tax structures and customs globally. Industrial companies can benefit from expertise in supply chain planning, automation, IT and global trade. Specialized internal and external service organizations are well positioned to respond to this need, supported by new technologies such as cloud, blockchain, analytics, the Internet of Things and machine learning. Glenn Steinberg, Advisory Principal, Performance Improvement Supply Chain & Operations, Ernst & Young LLP Page 3

4 Key themes 7 Innovation and new product/service launches Focus on digital technologies, R&D and product innovation Digital technologies and data analytics to provide mid-term and long-term benefits, both for internal operations and for products and services Technologies being deployed in more creative combinations (such as incorporating artificial intelligence into the Industrial Internet of Things to expand potential of service offerings) Partnerships, joint ventures and strategic acquisitions supporting innovations in digital offerings Increased commitments to R&D spending to increase innovation capacity and support expansion of new product pipelines Greater emphasis on bringing innovation to market, such as comparisons of new product launches in 2017 to prior years Reorganization of internal resources at one peer to better support technology integration into new products Next-generation A&D programs on track 8 Cost reduction Focus on controlling costs in all parts of the organization Success of prior cost reduction programs cited by many peers in yearon-year margin comparisons Cost synergies become a more critical part of the value of acquisitions as described to investors, leading to more detail in disclosure of projected targets and timelines SG&A continues to be a cost reduction target for some peers, supported by efforts to streamline organizational structures Balance sheet cleanup creates cost reduction opportunities Digital tools allow organizations greater insights into their own cost structures With rapid expansion through new business combinations and the repositioning of products and services to support a digital agenda, many companies are seeking to restructure the underlying cost base and reinvest in go-to-market and operating model capabilities to fuel growth. We have seen renewed interest in approaches such as zero-based budgeting as a mechanism to drive more rigor around cost control. Sonia Sande, Principal, Advisory, Ernst & Young LLP New 9 Critical projects While there were not many new large projects in 3Q, IP peers anticipate large project orders during 4Q17 and 1H18 Production updates and milestones for key projects crucial to company strategy Increased government focus on infrastructure projects, particularly in emerging economies, likely to result in large project orders Successful test flights and ongoing certifications for new aircraft models and defense platforms at multiple A&D manufacturers A&D players adjusting production rates and ramp up plans as several key projects transition from development to delivery phase 10 Transaction strategy (future plans) Future-facing discussions about mergers, divestitures and joint ventures Continuing a 2Q trend, greater detail shared by leaders in 3Q than in previous quarters about interest in identifying and pursuing acquisition targets Bolt-on acquisitions being considered by peers across all industrial subsectors to boost market share in key growth markets and product categories Valuations for targets remain high, limiting deal activity on concerns about investment returns New technologies and innovative processes attracting buyers looking to improve internal operations and external products/services; the technology acquisition can be even more important than the product, says one peer Divestitures continue from ongoing efforts to streamline portfolios and reduce non-core operations Scope, limitations and methodology This analysis examines key themes from the 3Q17 earnings reporting season among 21 global industrial products peers, including companies from the chemicals and aerospace and defense sectors. The identification of the top 10 themes is based solely on an examination of earnings calls held from 19 October through 9 November. Page 4

5 Key contacts Jerry Gootee Advisory Leader, Industrial Products Priyanka Chaudhry Tax Leader, Industrial Products EY Americas EY Asia-Pacific Karambir Anand Transaction Advisory Services Leader, Industrial Products Chee Soon Tham Assurance Leader Singapore, Industrial Products David Gale Transaction Advisory Services Leader, Industrial Products EY Europe Magnus Kuchler Advisory Leader Nordics, Industrial Products Christian Schibler Assurance Leader GSA, Industrial Products Aymeric De la morandiere Assurance Leader WEM, Industrial Products aymeric.de.la.morandiere@fr.ey.com Marco Mignani Assurance Leader MED, Industrial Products marco.mignani@it.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com EYGM Limited. All Rights Reserved. EYG no Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com Page 5