U.S. industrial shares falter on cost and trade worries

By Lewis Krauskopf

NEW YORK (Reuters) - U.S. industrial companies as a whole have been reporting strong first-quarter results, but in general that has not been enough to lure investors to their shares.

Investors are focused on U.S. tariffs and trade tensions and companies' warnings on rising costs, even as industrial companies' profits and revenue are topping Wall Street's estimates at a higher rate than other large companies. "It's not the current quarter that's the issue," said Walter Todd, chief investment officer with Greenwood Capital in Greenwood, South Carolina. "It's the guidance around what they are seeing from a cost perspective and what that means for margins."

Caterpillar Inc , the world's largest heavy equipment maker; 3M Co ; and Stanley Black & Decker Inc are among companies that have pointed to higher material, commodity or other costs in their reports to investors.

Since the first-quarter reporting season began in earnest in the third week in April, the S&P 500 industrial sector <.SPLRCI> has lagged the overall S&P 500 , falling 3.5 percent against a decline of 1 percent for the broader market. Industrials, which investors see collectively as a reflection of the economy's health, touched their lowest point in more than seven months on Thursday, though the sector index closed slightly higher.

The lagging share performance has come even as 81 percent of S&P 500 industrial companies have beaten analysts' quarterly earnings estimates and 88 percent have beaten revenue estimates, according to Thomson Reuters I/B/E/S. That compares to 78.5 percent of the overall S&P 500 beating profit estimates and 75.3 percent beating revenue projections.

The overall size of the industrial sector's earnings beat has been the second largest of the 11 major sectors, according to Thomson Reuters, behind consumer discretionary.

The share prices, however, reflect concerns over higher costs chipping away at profit margins, as well as other factors, investors say.

Some manufacturers that have warned about paying higher prices for materials have cited President Donald Trump's tariffs on steel and aluminium imports. "The market is concerned a little bit about raw material cost inflation crimping margins, maybe the inability for industrial companies to raise prices," said Andrew Meister, an equity analyst covering industrials for Thrivent Investment Management.

Trump's tariffs on metals have also stoked fears about the potential for escalating trade tensions, and investors have focused on industrial companies because of their dependence on China and other international markets. A U.S. delegation arrived in Beijing on Thursday for talks on tariffs, with state media saying China will stand up to U.S. bullying.

"Every time it is in the headlines, investors understand that industrials are one of the sectors more exposed to trade with China," said Kate Warne, investment strategist with Edward Jones in St. Louis. The report by Caterpillar, which serves as a proxy for global economic activity, of its quarterly results on April 24 set off the broader concerns that industrial companies' financial results may have already reached peak levels.

Caterpillar cautioned that it would not have the same pricing power to pass on increased material costs and said its first-quarter profit represented the "high-water mark for the year." Caterpillar shares tumbled 6.2 percent that day even though its quarterly profit and revenue trounced estimates. Warne called Caterpillar's comment "almost a bellwether remark." "Somebody says something like that and investors say, 'Wow, it could be not just them, but everybody,'" Warne said.

Despite their recent underperformance, industrial stocks still have believers, especially investors with a strong outlook for the global economy. Industrials are typically considered one of the sectors whose performance is linked to economic cycles.

"As growth improves, we see these cyclical stocks, like (consumer) discretionary and industrials, performing well," said Tracie McMillion, head of global asset allocation strategy for the Wells Fargo Investment Institute.

(Reporting by Lewis Krauskopf; editing by Alden Bentley and Leslie Adler)