In the three weeks since we wrote that engineers were in bargain territory the sector has risen as much as 7 per cent. That's a solid performance, but US peers have made some uncomfortable noises in their earnings reports and industrial data has been poor, both here and overseas. Nervous analysts have trimmed forecasts, too, and with the second-quarter results season almost upon us, further downgrades look highly likely.
American engine maker Cummins and Swedish industrial bellwether SKF have already reined in expectations, largely due to slower growth in China and Europe. A US manufacturing sector contracting for the first time in three years is worrying, too. Citigroup acknowledges pressure on 2012 earnings estimates, but believes the need for "a reset of expectations for 2013" is the real issue. It’s already cut forecasts by 3 per cent for this year and 8 per cent for next, and expects others to follow suit. So does Bank of America Merrill Lynch. The broker is rattled by the sector forward PE ratio, which is nudging 11 compared with nine when last year's eurozone crisis was in full swing and under seven at the trough in 2008. Of course, industrials are far stronger now, having repaired balance sheets and bolstered margins. And, according to Citi, reduced growth is already priced in. But year-on-year declines are not, and any earnings miss this results season will raise doubts about the sustainability of so-called 'peak margins'. "In nearly all cases, any margin expansion from here is, similar to top-line growth rates, likely to be slower than in the past," says Citi. A weak euro is no help to our exporters, either.
So, who's at risk? Cookson looks vulnerable, but its break-up story should offset weak steel markets. Weir has had a rough ride and its fracking pumps business is under the microscope, although the shares are cheap and its minerals division promising. European exposure could injure Bodycote and Morgan Crucible, yet aerospace engineer Senior, which supplies Cummins, looks oversold to us, and Fenner too. Elsewhere, margin gains will help IMI, but Rotork and Renishaw must impress to justify their premium ratings.
