Machinery & Diversified Industrials:Narrowing Sector Leadership_Tough Outlook, Low Expectations-1507

We expect 2Q earnings and outlooks to reflect a sluggish global industrial economy,with added pressure from continued commodity weakness (less so grains) & furtherUSD headwinds. Shorter cycle indicators in the US (industrial distributors) andEurope (i.e. SKF) show scant signs of upturn, and EM activity remains weak. Thatsaid, we think gross margins for the group could be more resilient on restructuringbenefits and price/cost, and investor sentiment points to low overall expectations.Net/net, we are making only modest adjustments to EPS ests and target prices.

    Key Focus Areas — Some of the key themes we are watching include: 1) Ability tohold pricing in light of commodity cost deflation and USD strength; 2) pace ofunderlying US construction activity; 3) Oil & Gas weakness spreading beyondupstream, post Rolls / GE’s order commentary; 4) expectations for pace of 2H15Europe recovery; 5) read-thru on China hydraulics post Zoomlion preannouncement;6) Aero aftermarket in light of mixed messages from variouscompanies and impact of low oil price; 7) early reads on NTM capex from UStruckload operators given spot price weakness, and 8) capital deployment “shifts”given prospect for US rate hike.

    Company Previews — See inside for overviews for most companies in ourcoverage. We do not anticipate significant new information to emerge from 2Qearnings, and expect fairly marginal tweaking to full-year guidance ranges.

    Advocate a Selective Approach — On top of the long (and well-known) list ofheadwinds facing the U.S. Machinery group, seasonality is also not a friend of thestocks, as Cap Goods stocks have historically underperformed in the Jun-Octtimeframe. We are recommending a narrow list of stocks in this backdrop, with DE,ETN, CMI, PH and URI all offering attractive risk-adjusted upside.