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Article | Executive Pay Matters

Industrials sector pay-for-performance update: 2019 performance jeopardizes target incentive payouts

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By Alex Ha and Niko Soforo | October 2, 2019

Financial results are tracking below 2018 results and investment analysts’ estimates for 2019 — suggesting incentive earnings may trend below target.

Despite investor optimism around the further adoption of digital technology, global uncertainties around the trade dispute between the U.S. and China make the second half of 2019 a challenge for the industrials sector. Industrials sector financial results through the first two quarters of 2019 trended below the same period last year, and they are tracking below current investments analysts’ expectations for the year.

Our article this quarter updates 2019 industrials sector performance trends and expectations, complementing our last update that focused on the pay implications of 2018 performance. Annual incentives for 2018 increased and sustained above-target payouts, while long-term incentives (LTI) rose to above-target payouts from target award the year prior. (For more details, see “Industrials sector 2018 pay-for-performance update: earned incentives trended above target,” Executive Pay Matters, July 16, 2019.)

Figure 1 reviews early 2019 expectations compared with 2018 results. Analysts generally expected weaker income statement and cash-flow growth than in 2018. Yet returns on equity (ROE) were expected to increase, a trend observed in the broader S&P 1500.

Figure 1. Industrials sector analysts’ growth expectations for 2019
Figure 1. Industrials sector analysts’ growth expectations for 2019

Source: S&P's Capital IQ database

Figure 2 shows financial performance results are down in the first half of this year compared with the same six-month period last year:

  • Income statement growth and margins are depressed versus last year.
  • Returns have also deteriorated or remained stagnant.
  • Cash-flow growth, however, has slightly increased.

In contrast, the industrials sector experienced double-digit total shareholder returns over the first six months — reflecting investors’ confidence — although the third quarter has been volatile.

 
  Industrials sector median*  
Measures 1st half 2018 1st half 2019 2019 trend
Income statement      
Revenue growth 10% 4% This is a red arrow pointing down indicating a downward trend
Earnings before interest and taxes (EBIT) growth 13% 6% This is a red arrow pointing down indicating a downward trend
Earnings per share (EPS) growth 21% 9% This is a red arrow pointing down indicating a downward trend
EBIT margin 10% 10% This is a yellow arrow pointing to the right indicating no significant change in the trend
Net income margin 21% 7% This is a red arrow pointing down indicating a downward trend
       
Balance sheet      
Return on net assets 12% 11% This is a red arrow pointing down indicating a downward trend
ROE 14% 14% This is a yellow arrow pointing to the right indicating no significant change in the trend
EBITDA**/interest expense ratio 12 11 This is a red arrow pointing down indicating a downward trend
       
Cash flow      
Cash-flow growth 4% 5% This is a green arrow pointing up indicating and upward trend
Cash-flow return on net assets 8% 9% This is a green arrow pointing up indicating and upward trend
       
Market-based measures      
Price/earnings ratio 21 20 This is a red arrow pointing down indicating a downward trend
Total shareholder return (TSR) -4% 22% This is a green arrow pointing up indicating and upward trend
       

Figure 2. Industrials sector first-half performance scorecard

*Financials through first two quarters; TSR represents composite performance through June 30, 2019
**Earnings before interest, taxes, depreciation and amortization
Source: S&P's Capital IQ database

Analysts have generally lowered their expectations for the industrials sector as the year has progressed, with income statement results currently tracking with analyst expectations. Whether the performance will be strong enough to maintain incentive payouts around target depends on whether companies took a conservative or aggressive approach when setting 2019 incentive plan goals.

The sector will be challenged in the second half of 2019, particularly given the uncertainty of the ongoing trade disputes between the U.S. and China. These uncertainties complicate preliminary thinking about 2020 incentive plan goals.

As part of the annual goal-setting process, more companies are bringing additional analytics to the discussion, including predictive analytics. Willis Towers Watson’s predictive performance model (PPM) helps clients measure the probability of achieving goals and aligning pay and performance. To learn more about PPM, follow the link here and watch a brief video (mid-page) explaining how our model can help you calibrate your incentive plan goals.

For a look at first-half results for 2019 in the broader S&P 1500, see “S&P 1500 pay-for-performance update: Will weaker 2019 performance reduce incentive payouts?Executive Pay Matters, October 2, 2019.

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