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Fitch: Commodity Cycle Reversal Discourages Capital Spending

May 11, 2016, 07:00 AM
Filed Under: Economy

The reversal of the commodity super cycle continued to discourage capital spending and depress results for diversified industrials and capital goods manufacturers in first-quarter 2016, according to Fitch Ratings. End-markets such as mining, oil and gas and agricultural equipment continue to face significant pressure, while the heavy duty truck market has recently weakened.

Most diversified industrials and capital goods manufacturers reported sales declines in the first quarter, although in some cases, the pace of decline moderated. Lower sales reflect a combination of low or negative organic growth and the adverse effect of the strong dollar.

Fitch expects sales and margin weakness will continue through 2016 and into 2017, even as the price of oil and other commodities have recently shown signs of stabilization. The downturn started at different times in these markets and there is little visibility into the timing of a recovery. There is a risk that recoveries in these markets could be muted compared with previous upturns, and Fitch maintains its negative outlook for the diversified industrial and capital goods sector.

Fitch sees the potential for negative rating actions in 2016, especially for companies that combine weak results with aggressive share repurchases and acquisitions, leading to higher financial leverage. Issuers that are on Negative Rating Outlook include Dover, Kennametal and Harsco. However, most Rating Outlooks are Stable as underlying cyclicality is reflected in the ratings. Furthermore, there are areas of strength in certain business segments within commercial aerospace and construction in North America. However, downside pressures predominate, and there are few scenarios where Fitch sees strong positive trends.

Global demand for new mining equipment likely will decline for a fourth consecutive year in 2016, reflecting sharp reductions in capacity expansion by mining companies. Mining production has been steady, but high levels of parked equipment are keeping capital spending for new equipment below replacement levels. Fitch estimates that Caterpillar's exposure to mining could result in a cumulative sales reduction that exceeds the 38% decline in 2009.

Sharply lower oil prices since mid-2014 have led to a material reduction in energy production, particularly in the upstream sector, leading to lower orders for power generation and drilling equipment made by industrial companies including Cummins, Dover, GE and others.

After peaking in 2015, sales of heavy duty trucks in North America appear likely to be down substantially in 2016 (FTR expects sales to decline 26%), due to weak industrial activity and overproduction by truck makers. In contrast to heavy duty trucks, production and demand for medium-duty trucks have been well balanced and production should be relatively steady, partly supported by freight volumes, which are growing slowly as rising consumer spending offsets weak industrial activity.

Although US construction activity is growing, equipment demand is being negatively affected by slow growth in emerging regions, recession in Brazil, the strong dollar and sharply lower activity in the oil and gas market.

Furthermore, high crop inventory and low crop prices are contributing to a significant reduction in net cash farm income in the US and, consequently, lower demand for farm equipment. Cash income could decline further in 2016 to $90 billion as projected by the USDA, a level roughly two-thirds of the record level reached in 2012.

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