Pentair executives didn’t use the words “industrial recession” in adopting a newly pessimistic outlook as they announced quarterly results last week. But if what they did say got translated into ordinary English, it comes out as “industrial customers right now don’t seem to want to spend any more money on the kind of things we sell.”
That sure sounds like a recession.
What Credit Suisse analyst Julian Mitchell found interesting about this is that Pentair got into this industrial slump later than some of the other industrial companies his research team follows, some of which have been struggling to get any sales growth for nearly 2 years. “Our forecasts assume that Pentair organic sales decline for three consecutive quarters, before flattening out in [the second quarter of 2017], which may prove optimistic,” Mitchell added, in a note to investors.
Pentair — which provides products and systems used worldwide in the movement, storage and treatment of water — remains nicely profitable and only trimmed expectations rather than slashing them. Executives explained how in a normal year, customers spend more as the end of the year approaches, using up the remaining capital budget and making sure planned projects get done by the end of December. Based on what’s happened so far this fall, the company now thinks there’s no reason to expect that to happen this year.
Pentair, formally based in the United Kingdom but run out of Golden Valley, also has seen customers delay spending even on maintenance and repair items. That’s the kind of thing companies do only when they expect their own business trends to worsen.
“There are some deferrals, there are push-outs into ’17,” said Rusty Zay, senior vice president for the Americas for Golden Valley-based Tennant Co., another manufacturer cautious about sales growth from industrial customers. “Or capital budgets just become tighter, and therefore the approval process … just takes longer.”
For those wondering why economic growth has mostly been bumping along at about 2 percent annually rather than 3 or 4 percent as it has in past, here we’ve got one big part of the explanation.
The stories told by Pentair and others are reflected in the economic data, too. The latest news was of relatively strong quarterly economic growth, but orders for durable goods also got announced last week, showing a decline in September. Orders that exclude airplanes and defense purchases — the closest thing economists have to understanding the purchasing behavior of businesses — declined 1.2 percent in September.
“This durable report reaffirms a long-standing trend of lackluster business investment,” said Stifel Financial economist Lindsey Piegza in a note last week to Stifel clients. “Despite healthy balance sheets, corporations are hesitant to invest in equipment, structures or high-wage, full-time employees.”
We’ve long heard that it’s the consumer now pushing the economy forward, and that’s certainly still accurate. From 1970 to 2010, manufacturing as a share of U.S. economic output declined from just under a quarter to not quite 13 percent. A similar transition has generally been happening all over the globe, as the global economy moves into the information age.
But what businesses spend on new buildings and equipment still plays a large role in economic growth. In looking at the history of business cycles, businesses usually start cutting back on capital spending before the broader economy slips into recession.
It’s easy to see how that works. Imagine a manufacturer’s CEO looking over a pessimistic new forecast of 2017 sales just before stepping into a meeting to go over the next year’s capital spending budget. When the executive team emerges two hours later, the capital budget that’s going to go to the board of directors for approval is now only 75 percent of what was in the draft budget earlier that day.
A lot of other businesses are counting on getting a piece of that 2017 spending budget. When they catch wind of this plan to spend less, they have to bring down their own 2017 sales forecasts, too. Then their CEOs have to tell the executive team to cut their own 2017 capital budgets.
As this continues to ripple out to other suppliers and their suppliers, it doesn’t take long before jobs start to disappear.
As difficult as it’s been for some industrial companies to get any growth, though, it’s no time to panic. There are always parts of the economy not doing well, individual industries or even whole regions of the country. Managing a big company well takes a portfolio approach, where the hope is always that several markets are booming if another one is slumping.
Tennant is a maker of floor-cleaning equipment among other products, and sales to equipment rental companies have been a bright spot, Zay said. Growth also has come from markets like education and health care. He called last week from a big trade show in Chicago for building managers, janitorial service providers and others in what could be called the commercial market, and he described the buzz on the exhibition floor as sounding optimistic.
As for the industrial market, Zay said, “right now we continue to see global uncertainty.”
Pentair responded to questions in an e-mail, and one of the points an executive made was that it doesn’t expect the current slump in orders for maintenance and repair items to last very long.
The analysts following Pentair seem to think that in 2017 the company would be lucky to get any sales growth at all, assuming no acquisitions, with sales growth resuming in 2018. Hopefully by the time Pentair and other manufacturers climb out of their industrial recession, the American consumer is still willing to spend.
If not, we won’t be talking about anything other than a regular recession.