(By David Sterman) Lost in all of the noise of a slumping, rebounding and slumping-again global economy
is a remarkable success story. A wide range of U.S. manufacturers have been sharpening their game, and are now retaining or even taking market share
from tough competitors such as Germany, Japan, China, Brazil and elsewhere.
Indeed, the rising tide of exports from U.S. factories to foreign markets has been one of the most under-reported stories of recent years. It's the single biggest factor behind a long string of upside earnings surprises coming out of America's heartland, and I think it's where there are significant gains for investors.
From Alcoa (NYSE: AA) to Ford (NYSE: F) to Caterpillar (NYSE: CAT), American manufacturers are now dominating their industries and poised for better days ahead.
Sadly, the recent market meltdown has rendered this great story moot. Industrial stocks are being sold off aggressively, as if they were simply broken businesses. Sure, the slower global economy will hurt a bit, but these industrial stocks don't deserve the pummeling they've taken.
A quick glance through various earnings forecasts makes you wonder why investors think these businesses are broken. In many instances, analysts expect these companies to actually boost profits over the next few years as they continue to take market share and boost their internal manufacturing efficiencies.
Maybe the analysts are wrong. Perhaps these companies won't deliver the sold profit growth expected of them and will simply generate flat profits until the rest of the world gets back on its feet. We'll get a better read in a month or so when second quarter results start to roll in.
For now, we can only see how these industrial stocks are trading in relation to current analyst forecasts. And boy are they cheap. I've compiled a list of 13 industrial stocks (or companies that serve the nation's industrial base of manufacturers), focusing on companies that are expected to keep boosting profits at a healthy clip. Each one trades for less than nine times projected 2013 profits (and less than 7.5 times projected 2014 profits). Every stock has moved down more than 30% from its 52-week high, putting them back in the "on sale" bin.
Solid value at this price
To be sure, these will never be high-multiple stocks, simply due to the cyclical nature of their annual operating results. For most industrial stocks, the forward multiple can typically move into the teens when earnings are depressed, as investors start to value them against better expected results down the road. And when earnings hit a cyclical peak, EPS starts to fall -- and they will rarely be valued at more than 10 times earnings. The fact that many of these stocks trade for much less than that on somewhat-depressed 2013 results highlights the fact that shares have plenty of room to rise as earnings forecasts start to build into mid-decade.
A good company can make money even in a slump
We can look at United Rentals (NYSE: URI) as an example of how investors may be misreading where we stand in the current industrial cycle. The company rents a wide range of construction equipment, and has seen results being constrained by a still-weak construction market.
Still, ahead of any uptick in construction activity, management is doing a solid job of focusing on the bottom line. EBITDA is expected to roughly double this year to $1.8 billion, aided in part by an acquisition. Once the synergies have been fully derived from that acquisition, EBITDA is expected to rise another 30% to $2.4 billion in 2013, according to Goldman Sachs. That should set the stage for EPS of nearly $5 in 2013, and this figure is likely to approach $6 by 2014 when construction activity builds higher. Shares have fallen from $45 earlier this spring to a recent $32, well below Goldman Sachs' $50 price target.
This company's transformation unlocks profits
Even as the economy stumbles on its path to firmer growth, many industrial companies have been streamlining processes and developing new products to boost sales and profits. Allegheny Technologies (NYSE: ATI) is a clear-cut example, as the company has moved away from its steel-making roots and pursued valued-added niche markets such as specialty metals that are used in aerospace, medical and energy industry applications. For example, the company's titanium products help jet engines burn hotter, which improves combustion.
After $2 billion worth of investments in the business, its transformation is now largely complete and Allegheny looks poised for solid secular growth, regardless of whether the economy grows at a tepid or moderate pace. The company's EBITDA should exceed $750 million this year, and analysts see that figure surpassing $1 billion in 2013.
A falling level of capital spending should eventually convert much of that EBITDA into rising free cash flow. Free cash flow is likely to be break-even this year, before approaching $2 a share in 2013 and perhaps more than $4 a share in 2014, according to consensus forecasts. Shares, which have slumped from $65 a year ago to a recent $30, don't begin to reflect that kind of free cash flow strength.
Risks to Consider: Many of these industrial firms rely on exports and the EPS forecasts in the above-noted table may need to be trimmed a bit.
Action to Take --> This is a good time to research these industrial stocks ahead of second-quarter results. If these companies can support the analysts' views that sales and profits can hold up -- and possibly grow -- in this tough environment, then investors will start to take note of these very cheap stock prices. But if you wait too long, your chance to grab a good stock at a bargain price may be gone.
-- David Sterman
David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of F, AA, in one or more if its "real money" portfolios.
This article originally appeared on StreetAuthority
Author: David Sterman