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Industry Analysis: Machinery
The Machinery Industry is a cyclical, capital-intensive sector. Major markets served include agricultural, construction, energy, industrial, infrastructure, mining and transportation. Among the varied products and services are tractors, engines, compressors, generators, cranes, tools, logistics, financing and remanufacturing. North America, Europe, the Middle East and Asia are the most significant geographic markets, but there are few, if any, countries around the world not served by the Machineries.
Common strategies for optimizing profitability can be identified here. Six Sigma, Lean Manufacturing and Best Practices are among those widely utilized. Working capital and cash flow management are crucial to a company's success. Internal and external expansion may be funded with cash, equity and/or debt. Ultimately, companies aim to grow and reward investors with share-price appreciation.
Machinery stocks are best suited to investors seeking above-average capital gains. Such market participants must be mindful of the macroeconomic environment, given the industry's close links to the business cycle. Ideally, investors with a 3- to 5-year view should buy into the sector when end markets have bottomed. Momentum investors can benefit in the midst of an economic upswing.
In a typical business cycle, there are markets that may be classified as early, mid, or late cycle. For example, transportation activity picks up early in an upturn, capital goods demand is strong in mid-cycle, and energy is a late-comer. Long-time investors know that the stock market cycle usually portends swings in the broader business arena. Equipment order trends and backlogs are good indicators as to what point a company may find itself in the business cycle. Other indicators are capacity utilization, inventory, staffing and capital outlays.
Attempting to smooth the ride over the business cycle, Machineries have endeavored to expand the types of equipment, extend geographic coverage, provide product-lifecycle management, sell remanufactured products, and offer repair, maintenance and overhaul services. Within its area of expertise, a company may try to develop or acquire products, assets and services that are counter-cyclical to each other. Locating manufacturing close to customers can allow for better service and provide a hedge against negative foreign currency exchange effects. A wide array of services and parts business lends recurring revenue and operating profit, thus adding stability to a company's overall performance.
Competing for customers, Machineries may strive to develop value-added equipment, creating a barrier to market entry. They will locate facilities in countries with well-educated populations. Pricing can offset high overhead. Conversely, Machineries that produce commodity-like offerings need to have expansive distribution and support networks. Manufacturing will be found in low-cost locales. Volume is important, because of thin margins.
Throughout the business cycle, managements act to maximize earnings. Production needs to be flexible, limiting the amount of idle capacity in difficult times and getting the most out of assets when business is robust. Segment reviews should be conducted regularly. Out-performers ought to be expanded and under-performers de-emphasized. Component outsourcing and part-time workers can contain costs when operations are running flat out, and eliminated when times turn tough.
Six Sigma is used to improve quality via enhanced manufacturing processes. This statistical management tool helps to eliminate defects and save money. It covers a wide spectrum of issues from product attributes to customer satisfaction. Many Machineries find Six Sigma useful, though it can be difficult to implement. Lean Manufacturing calls for the elimination of resources used in a process that do not benefit a customer. It may utilize just-in-time and automated production. Savings can be reaped from lower raw material purchases, enhanced inventory control, and more efficient staff and asset utilization. Best Practices can be defined as getting the most out of a process or organization with the least amount of effort. Well-run businesses work to extend a successful practice in one area to all operations.
Restructuring (i.e., staff cuts, facility consolidations, product eliminations, divestitures) should be done on an ongoing basis. Other than writedowns of discontinued operations, such expenses should be considered a cost of doing business. When these expenses are unusually large, investors should be cautious, since this can raise the level of operating and investment risk.
The best use of cash for a Machinery company is for growth. Investment in research and development and acquisitions is important to keep sales and earnings moving higher. Cash provides economical funding for small acquisitions that can bring new products to the fold or access to untapped markets. Large acquisitions are funded with equity, when the company's stock is performing well, or debt, assuming reasonable terms are obtainable. Management needs to take care not to overpay for assets. Capacity expansion should be undertaken only when assets are fully utilized and demand prospects are positive.
During weak periods, companies likely will use cash to buy back stock and increase the dividend to support the share price and reward investors. (A dividend is not a key consideration for Machinery investors, given typically low payout ratios.) In tough times, companies might also step up debt retirement, thereby boosting financial strength.