BOSTON — The average industrial stock in the S&P 500 has gained 38% in 12 months, more than twice the rise of the broader market.
Industrial stocks are still favoured by analysts, ranking third of 11 industry groups, because appetite for resources and infrastructure in emerging markets is amplifying demand.
Goldman Sachs named the following six industrial stocks to its 2011 Conviction Buy List, with one as a short recommendation. Below, they are ordered by predicted return, from plenty to most.
As Goldman notes, Dover is no longer a contrarian story. Its stock has surged 61% in 12 months and delivered annualized gains of 17% over a three-year span. It is an analyst favourite, receiving nine “buy” recommendations and three “hold” calls. No researchers advise selling its stock. Dover yields 1.7%. The dividend has grown 12% and 10%, annually, over three- and five-year spans.
Despite the solid run over the past year, Dover’s stock is comparatively inexpensive, selling for 14-times forward earnings, 2.7-times book value and 13-times cash flow, 25%, 30% and 18% machinery-industry discounts. Goldman expects the stock to advance 13% in the next 12 months to $75. Dover’s fourth-quarter adjusted earnings increased 59% to 94 cents, beating analysts’ consensus forecast by 15%. Dover’s sales exceeded the consensus target by 6.8%. In reaction, Goldman boosted its 2011 earnings estimate to $4.30 and its 2012 earnings target to $4.60.
Bears are concerned about Dover’s electronic technology segment, which sells products ranging from specialty audio components to microwave filters. But, management boosted its guidance for the segment in 2011. Goldman is optimistic about “structural change directed by new management in the areas of cost management and capital allocation.” Dover’s quarterly operating margin rose from 12% to 14%. Also, Dover offers “late-cycle exposure to oil and gas.” The fluid management division sells components to energy companies.
Its stock has rallied 11% in the past three months, but Goldman ranks it “sell” and expects 14% of downside to $70. Lockheed delivered solid quarterly results, with earnings per share of $2.11, exceeding Goldman’s $2.05 forecast and the consensus estimate of $2.07. Still, declining segment profit and margin erosion are ongoing concerns for Goldman. The quarterly book-to-bill ratio came in strong at 1.6.
Goldman lifted its price target from $63 to $70 as the report lessened its degree of pessimism. On the basis of valuation, Lockheed is ostensibly attractive, costing 9.5-times forward earnings and 7.9-times cash flow, 42% and 25% industry discounts. But, in Goldman’s view, value doesn’t compensate investors for the company’s growth deficiency. With “ongoing expectation for increased pressure on defence spending and contractor margins (potentially over an extended period of time), it is challenging to see any meaningful growth in the near to medium term.”
Lockheed’s operating margin declined from nearly 12% to 8.8% during the fourth quarter. Lockheed’s 12-month earnings per share growth rate ranks in the 36th percentile for the aerospace and defence industry. Its gross margin ranks in the eighth percentile. The stock receives “buy” ratings from just 28% of analysts, indicating poor sentiment on Wall Street.
Eaton has a market value of $18 billion. Its fourth-quarter adjusted earnings stretched 25% to $1.69, outperforming researchers’ consensus estimate by 1.1%, a narrow beat. Its sales, up 17%, beat the consensus by 0.9%. It seems as though analysts have a grasp on Eaton’s growth trajectory, given precise quarterly forecasts. Goldman disagrees.
Calling the quarter “unspectacular”, it believes that analysts will be forced to upwardly revise their earnings estimates in the weeks ahead, boosting Eaton’s stock. Among the most bullish on the Cleveland-based industrial company, Goldman even sees significant upside to its own $132 price target. Eaton offers “late-cycle exposure to non-residential construction, energy and aerospace markets”, so is ideally-suited to outperform as the economic cycle matures. Currently, nine analysts rate Eaton’s stock “buy” and 11 rank it “hold.” No analysts rate the shares “sell.”
Goldman offers the highest target on Wall Street. Eaton is attractive based on its valuation. The stock has advanced 78% in the past 12 months, but costs just 12-times forward earnings, 2.5-times book value and 1.3-times sales. Those multiples reflect discounts of 32%, 36% and 19% to industry averages. Eaton pays a quarterly dividend of 68 cents, equal to a yield of 2.5% and a safe payout ratio of 43%. The dividend has grown 17% in 12 months. It has expanded 9.3% and 13%, annually, on average, over a three- and five-year span.
Goldman views Chicago Bridge & Iron as a levered oil play. Crude oil is trading above $90 a barrel, currently, and demand is growing amid the global recovery. Engineering and construction backlogs are inflecting and Goldman expects investors to start paying higher multiples for stocks in the sector, with Chicago Bridge & Iron offering the most upside. As the recovery progresses, this late-cycle group will rally.
Furthermore, Chicago Bridge & Iron’s stock is undervalued, trading at a trailing earnings multiple of 19, a forward earnings multiple of 15 and a cash flow multiple of 15, 35%, 36% and 50% discounts to industry averages. The company has a pristine balance sheet, with $361 million of cash and equivalents and $121 million of debt at third-quarter’s end. The company will release fourth-quarter results on Feb. 22. Most recently, it announced $90 million of work booked for the Kearl oil sands project, which missed Goldman’s full-year estimate of $600 to $700 million.
Still, Goldman expects the company to book significantly more business as result of the Kearl project. According to Chicago’s management, Imperial Oil “has yet to fully release Chicago Bridge & Iron’s potential scope on the project.” Thus, Chicago will miss its 2010 award guidance when it reports results in two weeks, but its “earnings story is intact.” The stock receives “buy” ratings from 71% of researchers in coverage. Macquarie, an energy-focused investment bank, forecasts that the stock will advance 45% to $50.
Fourth-quarter adjusted earnings advanced 34% to $1.84, beating the consensus target by 7.4%. Its top-line figure, up 22%, exceeded expectations by 5.1%. Cummins is the fifth best-performing S&P 500 stock of the past 12 months, having more than doubled over that span. Despite the outstanding performance, it remains fundamentally attractive. Its forward earnings multiple of 13 represents a 30% peer discount.
However, Cummins is expensive on the basis of cash flow, book value and sales per share. Goldman’s latest missive, stressing an accelerated share buyback program as the stock’s next catalyst, reiterated the bank’s “conviction buy” ranking. In the fourth quarter, the float decreased 1% to 196 million shares, marginally boosting earnings per share. Goldman believes that Cummins, which currently receives nine “buy” calls and eight “hold” recommendations, can exceed incremental margin guidance. It will continue to profit from rapid emerging markets expansion.
The bank cites exposure to accelerating U.S. truck and power generation markets as a catalyst. Goldman recently boosted its 2011 profit forecast to $7.59. It predicts 2012 earnings of $9.15 and 2013 earnings of $10.25. Higher penetration in China will be a major driver to growth. But, material inflation presents a significant headwind and Goldman expects 200 basis points of higher costs from input prices. Expense-cuts should help offset this obstacle.
The stock commands a trailing earnings multiple of 22 and a forward earnings multiple of 17, notable premiums to peer averages. But, Goldman gets “the sense that the stock has fallen somewhat out of favour.” Precision’s fiscal third-quarter adjusted earnings, announced Jan. 27, expanded 12% to $1.80, matching Goldman’s estimate and the consensus. Sales, up 16% year-over-year, beat researchers’ consensus estimate by 3.2%.
Goldman, consistent with its other picks, sees Precision as an ideal late-cycle play, predicting 20% revenue growth over the next three to five years. Goldman believes that Precision possesses “best-in-class management, returns on capital and cash generation, and a balance sheet already in a net cash position.” It expects its stock to rise 22% to $180 in 12 months.