Commodities, China key issues for manufacturers

By Scott Malone

NEW YORK (Reuters) - Strong demand for products ranging from water-filtration plants for the developing world to heavy equipment for miners and oil companies have helped U.S. manufacturers get off to a rollicking start in 2006.

Buoyed by a wave of solid first-quarter earnings reports, industrial stocks have posted gains that outpaced most major market indexes. But conglomerates still face a slew of challenges, including higher costs for raw materials.

Top executives from diversified companies including General Electric Co. (GE.N: Quote, Profile, Research, Stock Buzz), United Parcel Service Inc. (UPS.N: Quote, Profile, Research, Stock Buzz) and Siemens AG (SIEGn.DE: Quote, Profile, Research, Stock Buzz) will discuss how they are handling these trends at the Reuters Manufacturing and Transportation Summit in New York, starting on Monday.

The biggest issue the sector is facing is surging commodity prices, which is both a blessing and a curse, analysts said.

The rising price of oil and metals -- especially copper -- have driven up demand for industrial goods, spurring energy and mining companies look to raise production levels. But soaring prices are also pinching margins in the sector, with companies including Emerson Electric Co. (EMR.N: Quote, Profile, Research, Stock Buzz) and SPX Corp. (SPW.N: Quote, Profile, Research, Stock Buzz) citing increases in raw material prices as a headwind.

"As long as they're able to re-price and keep up with all the changing commodities prices ... all the signs on the economy look good" for the manufacturing sector, said Mike Gandrud, an analyst at Johnson Asset Management, a Racine, Wisconsin,-based value fund with $1.4 billion under management, and an owner of GE shares.

"The ones that are doing well are having some sort of a pricing reset in their backlog," Gandrud said. "They're saying, 'OK folks, we'll make it for you at this price, but if commodities move against us, we're going to push that through.'"

Oil prices have been testing highs around $75 a barrel this year, with lead-month U.S. oil futures CLM6 trading at $72.75 on the NYMEX on Friday. Copper prices have risen more than 70 percent so far this year, with COMEX copper futures HGN6 trading at $3.8350 per pound.

The Standard & Poor's Capital Goods Industry Group index .GSPIC has risen 9.4 percent so far this year, outpacing the 3 percent gain for the broad S&P 500 index .SPX.

DEVELOPING WORLD, DEVELOPING MARKET

For makers of heavy equipment -- everything from construction products to gas turbines -- demand has been driven by investment in infrastructure in the developing world, particularly China.

"This is all greenfield, with China putting up the equivalent of a Chicago every couple of months," said Peter Sorrentino, chief investment officer of Bartlett & Co., of Cincinnati, which manages about $3.2 billion in funds and holds shares in companies including GE, Honeywell International Inc. (HON.N: Quote, Profile, Research, Stock Buzz) and Illinois Tool Works Inc. (ITW.N: Quote, Profile, Research, Stock Buzz).

With a 9.6 percent rise in gross domestic product forecasted for 2006, China in particular has caught the attention of heavy manufacturers. GE aims to double its sales into China to $10 billion by 2008.

"Investors should look for those companies who get the greatest percentage of their revenue outside of North America," said Sorrentino. "The most powerful, most sustainable growth is elsewhere. It's not in Europe. It's really in Latin America, it's in Asia, it's in Africa."