By Kris Rosemann
US GDP growth slowed to 0.7% in the fourth quarter of 2015, down from 2% in the third quarter of the year. The deceleration was primarily due to a slowdown in personal consumption expenditures and decreases in nonresidential fixed investment, exports, and state and local government spending. The slowing of spending in both the public and private sectors was felt by industrial companies in the period, many of which reported less-than-spectacular results.
Currency headwinds also provided a drag on multinational industrial companies, such as 3M (MMM), Parker Hannifin (PH), Dover (DOV), and Illinois Tool Works (ITW). The US dollar is not expected to weaken relative to other currencies across the globe in the near term, especially when considering the negative interest rate policies in effect in Europe and Japan. Both the Euro and the Yen have weakened materially relative to the dollar as of late.
As can be expected from the rout in commodity prices, industrials are also experiencing significant weakness in their natural resource driven end markets. This weakness has caused some to look elsewhere for growth. Danaher (DHR) and Roper Technologies (ROP) are good examples of firms that turned to the acquisition of other industrial companies to drive growth in 2015.
Let’s take a look at how some of the major industrial players fared in the fourth quarter of 2015 and examine who might be in the best position for the remainder of 2016.
Health Care and Consumer Segments Carry 3M
3M’s reported top-line results came in as expected as multinational industrial companies continue to face pressure. Sales fell 5.4% to $7.3 billion in the fourth quarter of 2015, but even more off-putting was organic sales in local currencies dropping 1.1%. Of no surprise, the company was led down by its Electronics and Energy segment, where organic local-currency sales declined 7.7%. Its Safety and Graphics and Industrial segments experienced low-single digit declines in organic local-currency sales.
Though revenue declined on an as-reported basis, the firm’s Health Care segment was its bright spot, as it grew organic local-currency sales by 4.5% from the year-ago period. The Consumer segment was the only other segment to grow organic local-currency sales, which increased 2.7% in the quarter. As a whole, earnings per share charges fell 0.6% to $1.80 in the fourth quarter when excluding $0.14 per share in restructuring charges related to corporate restructuring to reduce structural overhead.
Looking ahead to 2016, 3M expects organic local-currency sales growth of 1%-3% and earnings per share to be in a range of $8.10-$8.45 compared to $7.58 per share in 2015. These expectations assume somewhat healthier end markets moving forward and we would expect a similar growth trajectory to continue for its segments in 2016.
Challenging Market Conditions Persist for Parker Hannifin
Parker Hannifin reported total sales falling 14% to $2.71 billion in the second quarter of its fiscal 2016 as organic sales dropped 10% and currency headwinds contributed an additional 4% decrease. The firm’s diversified industrial segment, which has a considerable amount of exposure to oil and gas related end markets, saw its sales drop 16% in the period. Its Aerospace Systems segment was not able to buoy results, as its sales fell 1% on a year-over-year basis. Adjusted earnings per share performed just as poorly as the company’s top line, falling by more than 17% in the quarter to $1.52.
Perhaps most discouraging was the company’s 12% decrease in orders, which was led down by a 15% drop in its Diversified Industrial North American business. This descent does not bode well for future revenue trends for Parker Hannifin. The company now expects adjusted earnings per share to be in a range of $5.90-$6.30 for the full fiscal year, which excludes a realignment expense mostly due to its Simplification initiative, the success of which remains to be seen. Execution on its initiatives will be key moving forward, as management expects challenging market conditions to continue.
Dover Feeling the Pain of Low Crude Oil
Dover also experienced a difficult end to 2015, as its sales fell 14% in the fourth quarter on a year-over-year basis to $1.7 billion. Organic revenue dropped 12%and currency added another 4% of decline while acquisitions provided 2% growth. The firm’s top line continues to be driven downward by a difficult operating environment, particularly in the oil and gas markets. Diluted earnings per share excluding discrete tax benefits fell 20% from the year-ago period to $0.81.
Moving into 2016, rightsizing its business will be a key focus for Dover, particularly in its Energy segment, and it will continue to focus on free cash flow generation in a time of market weakness. The firm is expecting earnings per share to be in a range of $3.85-$4.05, and organic revenue is expected to decline (4%)-(1%) in 2016 as spending in the oil and gas markets remains subdued.
Danaher Reports Record Fourth Quarter Results
Growth from acquisitions helped Danaher to strong fourth quarter sales growth of 12.5% on a year-over-year basis to $5.9 billion. Acquisitions contributed revenue growth of 17.5% while core revenues remained flat. Non-GAAP adjusted diluted net earnings per share also grew at a low-double digit rate to $1.27, as it significantly expanded core operating margins. The firm also reported record free cash flow generation in the quarter.
In the fourth quarter, Danaher also announced multiple bolt-on acquisitions, which are anticipated to continue to drive growth in the company. As a more challenging economic landscape is expected to continue, Danaher has acquired a number of businesses to maintain attractive top-line growth. However, over the course of 2015, the firm’s long-term debt load has risen from ~$3.4 billion to more than $12 billion while its cash and equivalents balance fell from more $3 billion to less than $800 million. This increase in debt may not be an issue as long as the firm continues to generate strong free cash flows.
Danaher is expecting full-year 2016 adjusted diluted net earnings per share to be in the range of $4.80-$4.95, an increase of 12%-15% from 2015, but investors may want to keep an eye on its ability to generate significant free cash flows in order to handle its increased debt load.
Demand to Remain Steady for Illinois Tool Works
Illinois Tool Works reported total revenue falling 6.5% in the fourth quarter of 2015 from the year-ago period to $3.3 billion mostly due to currency headwinds; organic revenue fell 0.6% in the quarter. The firm’s Enterprise Initiatives–which targets optimal portfolio management, business structure simplification, and strategic sourcing–led operating margin expansion of 110 basis points to a record 20.7% operating margin. Earnings per share grew 4% to $1.23 from the same period in 2014, and when excluding the impact from foreign currency translation, earnings per share growth was a solid 11%. Free cash flow generation was strong in the period as well, as it grew 12% on a year-over-year basis to $628 million.
Demand for Illinois Tool Works’ industrial equipment has been sluggish in recent quarters, but underlying trends in its Welding and Test & Measurement/Electronics segments have been stable. On a sequential basis, overall demand remained stable, which is expected to continue in 2016. On an organic basis, revenue is expected to grow a modest 1%-3% from 2015 in the year, and the firm is anticipating its Enterprise Initiative to expand operating margin by approximately 1 percentage point, independent of volume growth. Full-year earnings per share will benefit as a result and are projected to be in a range of $5.35-$5.55, which represents a 6% increase from 2015 at its midpoint.
Roper Technologies Benefits From Focus Shift
Roper Technologies reported fourth-quarter revenue of $948 million, as organic revenue fell by 4%; currency headwinds provided an additional 2% top-line drag, and acquisitions and divestitures provided a 6% boost to pull reported revenue even with that of the fourth quarter of 2014. Consistent with other diversified industrial companies, the firm’s Industrial and Energy segments experienced weakness, and its Medical and RF Technology segments performed well. The company also deployed over $700 million in acquisitions in the quarter, which will help reported results moving into 2016.
The strength of Roper’s higher-margin Medical and RF Technologies segments helped the firm expand its overall EBITDA margin 60 basis points in the quarter. It is also in the process of integrating acquisitions in each of these segments, and they will continue to be a focus moving forward as the company looks to continue to grow into its name, which was recently changed to reflect a focus shift from industrials to a more diversified technology company. The strong EBITDA margins led to 2% growth in EBITDA and 3% growth in free cash flow on a year-over-year basis, as the company reported an impressive 140% free cash flow conversion rate.
Roper expects continued weakness in its Industrial and Energy segments. The Industrial segment is anticipating organic growth to fall in the low-single digits in 2016, while the Energy segment is expecting high-single digit organic revenue declines. The health of both segments is tied to the oil and gas markets, a major reason why the firm continues to adjust its focus away from these two segments. Both the Medical and RF Technology segments are expected to grow organic sales at a mid-single digit rate in 2016, driving total organic revenue growth of 2%-4% in 2016 and adjusted diluted earnings per share in a range of $6.85-$7.15, excluding future acquisitions or divestitures.