OREANDA-NEWS. Low commodity prices and muted levels of capital investment continue to constrain results for diversified industrials and capital goods manufacturers, according to Fitch Ratings.

Most diversified industrials and capital good companies reported sales declines in the second quarter although the pace of decline moderated for some companies due to easier year-over-year comparisons. Lower sales reflect the impact of depressed commodity prices, weakness in emerging markets and the strength of the dollar. Sales declines are widespread and have been ongoing for some time, evidenced by a downward trend in industrial production since the second half of 2014.

Companies selling into commodity-driven end markets such as oil and gas, mining and agricultural equipment have been the most affected. The heavy duty truck sector is also down sharply in 2016 as the industry adjusts to weak freight volumes. In contrast, the automotive, aerospace and US construction industries have continued to perform well, though low growth in emerging regions is negatively affecting demand for construction equipment.

Slower growth in emerging markets will continue to be a drag on diversified industrial companies for some time. And while growth in Europe has been a modest support to some companies, the Brexit process increases risk to demand in the UK and potentially across Europe over the next year.

Across the diversified industrials sector, Fitch expects sales and margin weakness will continue into 2017, even as the price of oil and other commodities show signs of stabilization. There is a risk that an eventual recovery in these markets could be muted compared with previous upturns, and Fitch maintains its negative outlook for the diversified industrial and capital goods sector.

Fitch sees the potential for negative rating actions in 2016, especially for companies that combine weak operating results with aggressive share repurchases and acquisitions, leading to higher financial leverage. Issuers on Negative Rating Outlook include Dover, Kennametal, IDEX and Harsco. However, most Rating Outlooks are Stable as ratings take into account underlying cyclicality.

Suppliers to the upstream oil and gas sector will continue to face significant headwinds over the next year. Oil prices, after recovering toward $50/barrel in June 2016, have reverted to the low $40 range. While the number of active drilling rigs could be nearing a bottom, oil and gas production activity will likely remain depressed well into 2017.

Lower demand for agricultural equipment reflects high crop inventory and low crop prices, which have led to a significant reduction in net cash farm income in the US. Cash income could decline further in 2016 to around $90 billion as projected by the USDA, a level roughly two-thirds of the record reached in 2012.

Global demand for new mining equipment likely will decline for a fourth consecutive year in 2016, reflecting sharp reductions in capacity expansion by mining companies. Mining production has been steady, but high levels of parked equipment are keeping capital spending for new equipment below replacement levels. Fitch estimates that Caterpillar's exposure to mining could result in a cumulative sales reduction that exceeds the 38% decline in 2009.