LONDON (ShareCast) - (Sharecast News) - A "sharp correction" is coming for the capital goods sector, broker Liberum warned on Thursday, leading it to downgrade engineering firms Bodycote and IMI.
The broker downgraded its opinion of the capital goods sector after its early cycle indicator (ECI) sounded a warning. The indicator is used to forecast the organic sales growth of early-cycle businesses and back-tested over 20 years has an 80% correlation with organic growth, with a six-nine month lead.

The ECI indicated a substantial drop in earnings.

"The sector has sold off on six of the seven previous occasions this has happened in the last 20 years, with an average decline of 33% in eight months. In prior periods with flat yield curves the sell-off was greater, while high inventories and extended delivery times may also cause further pressure," said analysts in the note to clients.

Liberum said that Bodycote is better placed than competitors to combat destocking and cost inflation that is likely to hit the sector due to its unique business model which involves holding no inventories.

The broker cut its rating on Bodycote to 'hold' from 'buy' and its target price for shares in the company to 940p from 1,025p, adding that margins "should remain resilient," helped by growth in its Specialist Technologies division.

In the case of IMI, the rating was cut to 'sell' from 'hold' and the target price to 1,020p from 1,275p, arguing that the expected destocking in 2019 would hit the firm's margins, precipitating a flatline over the 2017 to 2020 period.

A sharp slowdown in the company's Precision Engineering division drove Liberum's 2020 earnings per share forecast to 11% below consensus which, in sharp contrast, forecasts a record period of growth.

Bodycote was down 4.57% at 898.50p and IMI was down 4.71% at 1629 BST.

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