The pandemic isn't over yet, but manufacturers are reclaiming control over their recovery story.
During the most recent earnings season, the majority of industrial companies were able to issue full-year earnings and sales guidance for 2021. That's a change from last year, when all but a select few suspended their outlooks and many others shifted to quarterly or even monthly forecasts because that's as far ahead as they could see. What's really notable about the renewed guidance, though, is that for many companies it includes a step up in spending. An analysis of industrial firms that reported results in the first half of earnings season indicates a 20% increase in capital spending from last year's levels, Scott Davis of Melius Research wrote in a report. "While the world is nowhere near 'normal,' the data suggests that companies are feeling confident enough to take up spending levels materially," Davis said. That includes not only a catchup in maintenance spending that was delayed by the pandemic, but also investments in automation, digital technologies, environmental initiatives and Covid growth spots such as pools, face masks and residential air conditioners, he said.
The manufacturing sector is incredibly circular; one company's customer is another's supplier and vice versa. So an increase in capital spending buoys the whole sector, and by extension, the broader economy. Having said that, I hesitate to read too much into this early data. Many companies cut or rejiggered spending plans last year to deal with the effects of the pandemic, so there was plenty of room for a material snapback versus 2020. Emerson Electric Co., for example, is targeting about $600 million in capital expenditures in 2021, up from the $538 million it spent last year but about in line with its $594 million outlay from 2019. Caterpillar Inc. is targeting "normal" capital expenditures of about $1 billion to $1.2 billion, a pace in line with its pre-pandemic spending. Barclays Plc analyst Julian Mitchell has expressed skepticism that the industry is on the cusp of a major hardware spending spree that could justify sustained lofty valuations; after all, the pandemic is just one of many downturns manufacturers have weathered in the past decade and companies will be wary of getting burned. The nature of spending by the sector has also shifted, with software given a higher priority than factories.
On the other hand, the pandemic is still happening, so companies' willingness to commit to pre-Covid spending levels is a positive sign and suggests that there's capacity for even bigger budgets down the line. Some companies are already being bold: Stanley Black & Decker Inc., for example, is aiming to spend 3% of 2021 revenue on capital expenditures, implying a budget of about $460 million. That's not only more than the company spent in 2019, it's also Stanley's second-largest annual budget, based on data going back to 1987. Stanley also indicated it would exercise an option to purchase the remaining 80% stake it doesn't already own in lawn-mower manufacturer MTD Products Inc. later this year, a move that would add up to $3 billion in revenue in 2022. 3M Co., meanwhile, is planning to spend as much as $2 billion on capital expenditures this year, up from $1.5 billion last year. If it only ends up hitting the lower end of its 2021 spending target at $1.8 billion, that would still be a record on a total dollar basis, according to data compiled by Bloomberg.
The extent to which environmental, social and governance initiatives can be a driver of spending has also been underappreciated, Davis of Melius Research wrote. With more industrial companies laying out commitments to carbon neutrality over the next decade, that means investing in analytics to measure their progress, swapping out less efficient equipment for more environmentally friendly versions and building electric vehicle fleets to cut down on gas-guzzling trucks, he said. That all adds up.
3M, for example, is earmarking $100 million of its 2021 capital-expenditure budget for investments in improving water quality around its manufacturing locations and reducing water usage. (This is pulling double duty in the PR department, with 3M facing billions in potential liabilities tied to environmental contamination from PFAS chemicals.) Rockwell Automation Inc., which has said it's aiming to net out both direct and indirect emissions by 2030, is using a portion of a $70 million pre-tax legal settlement to further its investments in environmental initiatives. "We are spending a sizable amount of money — I mean in the millions of dollars — to make sure that we are going at a fast pace in terms of advancing those ESG goals in our own shop," CEO Blake Moret said on a call last week to discuss the company's earnings. Rockwell is also investing in new products to help its customers meet their energy-efficiency goals.
Raising the Stakes for Factory Workers
Speaking of ESG, and as I discussed last week, one way to tell which companies are really committed to social and governance improvements is by how they treat their workers during a rough patch like the pandemic. Things like not firing people and enhancing benefits are all good starts, but what can really make a difference is extending stock grants beyond the executive level and empowering factory workers as owners of the company. Harley-Davidson Inc. this week announced that it would issue stock to 4,500 employees, including all of its hourly factory laborers, as part of its latest turnaround effort. The inspiration for the grants came from KKR & Co.'s Pete Stavros, who has developed similar employee stock-ownership programs for companies across the private equity firm's portfolio including capsule manufacturer Capsugel and aerospace hardware company Novaria. At Ingersoll Rand Inc. — where Stavros serves as chairman and KKR is a major shareholder after a 2013 buyout — some 16,000 employees across the company received $150 million worth of stock last year. The idea is that employees who have a financial stake in a company beyond a simple paycheck will be more invested in its success. Equity ownership also helps narrow the gap between the millions earned by top executives and the average pay on the factory floor. It's telling that Harley — a company that's struggling to find its footing after years of sliding sales and margins — views employee stock ownership as a necessity, not a luxury. There's no reason why this practice can't be more commonplace; all manufacturing CEOs and board directors should be giving it more thought.
Big Plane Problems
Boeing Co. lowered its calculation of the backlog for its 777X jet, signaling more than a third of the order book may be at risk. Accounting standards require the company to remove deals that are unlikely to be completed, whether because of buyers' financial or because of contract provisions that offer more flexibility on cancellations in the event of extended delays. Boeing now expects the first delivery of the 777X to happen in late 2023 — three years behind the original schedule — and took a $6.5 billion charge on the program in the fourth quarter. Emirates, the largest customer for the jet, is seeking to switch 30 to 40 of its 115 commitments for the 777X to the Dreamliner as it recalibrates fleet plans, a person familiar with the matter told Bloomberg News. Things are looking at bit brighter over at Airbus SE, which won no new jet orders in January but also recorded no cancellations. Airlines are still more focused on culling jobs than buying new planes: American Airlines Group Inc. warned 13,000 employees they were at risk of losing their jobs once payroll protection grants expire at the end of March as a slower-than-expected vaccine rollout dampens the outlook for summer travel. That follows a similar warning to 14,000 United Airlines Holdings Inc. employees last week.
Deals, Activists and Corporate Governance
Eaton Corp. announced two takeovers worth a combined $4.5 billion. The larger of the two transactions is a $2.83 billion acquisition of Cobham Mission Systems, which makes air-to-air refueling systems for the defense industry. Eaton will also purchase Tripp Lite — a supplier of uninterruptible power supply systems and other data-center equipment — for $1.65 billion. What's interesting about these two deals is that they're reasonably priced. In a world of Reddit rallies, stratospheric SPACs and bloated balance sheets, this is a refreshing change of pace. Eaton is paying about 13 times 2021 Ebitda for the Cobham asset and a multiple of about 11 on the same basis for Tripp Lite. Both valuations lag that of Eaton itself, a contrast to some of its peers' recent splurges on pricey software and health-care takeovers. This also suggests these deals were a better use of cash than share buybacks would have been. While defense spending may have peaked in the U.S. near term, there's reason to think Cobham's refueling-systems business can continue to grow, given the push to replace America's aging tanker fleet, Gordon Haskett analyst John Inch wrote in a note.
Emerson Electric Co. is getting a new CEO. After more than 20 years at the helm, Dave Farr is stepping down as CEO and handing the reins over to Lal Karsanbhai, previously head of the company's automation division. It's the end of an era in more ways than one. Farr was one of the longest-serving CEOs among large industrial companies and the last of a generation of gregarious leaders with big personalities, including Jeff Immelt of General Electric Co., Dave Cote of Honeywell International Inc. and Brian Jellison of Roper Technologies Inc. They've all been replaced by technocrats who are apt to be remembered more for their operating expertise than what they said on a conference call, a reflection of the changing landscape for manufacturers. The big question is whether Emerson will now break up. The company declared last year that it wouldn't make any big portfolio changes without a "major strategic acquisition catalyst." The breakup math doesn't look that enticing, with investors seemingly giving Emerson close to full credit for its disparate parts in the current stock price. But heavy-duty factory automation equipment and InSinkErator garbage disposals aren't the most logical combination, and the new CEO may have a different perspective. Emerson is reportedly talking to advisers about a sale of its Appleton Group electrical-products unit, which could fetch $1 billion.
Exxon Mobil Corp. is reportedly considering adding activist investor and ESG advocate Jeff Ubben to its board amid growing criticism of the relatively blind eye it's historically turned to climate change and questions over the sustainability of its sacrosanct dividend. Exxon has already appointed former Petronas Chief Executive Officer Tan Sri Wan Zulkiflee Wan Ariffin to its board, but the move failed to appease first-time activist investor Engine No. 1, which has the backing of the California State Teachers' Retirement System and has nominated its own slate of four directors. Ubben's candidacy has reportedly already earned the support of another activist investor at Exxon, D.E. Shaw. Ubben's new firm, Inclusive Capital Partners, is discussing taking a meaningful stake in the oil giant in connection with his potential appointment, people familiar with the matter tell Bloomberg News. My colleague Liam Denning writes that Exxon has probably succeeded in assuaging near-term concerns about the dividend after making clear that spending will be trimmed before the payout, but "the bigger question — whether there's a long-term future for a $15 billion dividend as oil demand flattens and falls — remains hanging."
Jeff Immelt wrote a book about his tenure as GE's CEO. It's called "Hot Seat." According to the New York Times, the book is a mixture of an attempt at accountability for mistakes made over his 16-year tenure and a deflection of the blame onto other forces. I'm not going to spend a lot of time on this. This Times's headline — "Jeff Immelt Oversaw the Downfall of G.E. Now He'd Like You to Read His Book" — and GE's recent settlement with the Securities and Exchange Commission over allegations that it misled investors about the financial state of its power and insurance units tells you pretty much everything you need to know. But I do have to say I find Immelt's criticism of his successor John Flannery particularly tasteless. In excerpts quoted by the New York Times, Immelt says Flannery "created a culture defined more by victimhood than by a sense of purpose" and "couldn't make a decision." It's a bit rich coming from someone who is still disgruntled about criticism from his own predecessor, Jack Welch. I've done my fair share of criticism when it comes to Flannery, but there's no denying the fact that he inherited the mess he was left with from none other than Jeff Immelt.
Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
Disclaimer: This opinion first appeared on bloomberg.com, and is published by special syndication arrangement.