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Industrials Sector

Industrials Sector. Jason Kraynak and Wade Guzdanski. Agenda. Overview Business Analysis Economic Analysis Financial Analysis Valuation Analysis Recommendation. Overview. Industrials. Capital Goods

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Industrials Sector

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  1. Industrials Sector Jason Kraynak and Wade Guzdanski

  2. Agenda • Overview • Business Analysis • Economic Analysis • Financial Analysis • Valuation Analysis • Recommendation

  3. Overview

  4. Industrials • Capital Goods • Aerospace & Defense, Construction & Engineering, Electrical Equipment, Building Products, Machinery, Trading & Distributors • Commercial Services & Supplies • Commercial Printing, Data Processing, • Transportation • Air Freight & Logistics, Airlines, Marine, Road & Rail, Transportation Infrastructure • Market Cap of $1.55 Trillion

  5. Industrials Avg. % of S&P 500 Source: Factset

  6. SIM Portfolio Weight – 6/23/2013 • Industrials account for 10.7% of S&P 500, portfolio is currently underweight 234bps

  7. Current SIM Holdings • Shares in Danaher Corporation were sold as part of move to reduce portfolio to $10M prior to fiscal year-end

  8. Sector Industries • 88% of sector is comprised of three industries: Electronic Technology, Producer Manufacturing and Transportation

  9. Largest Companies

  10. Industrials Performance

  11. Business Analysis

  12. Industrials Life Cycle • Industrials sector is in the “Maturity” phase • Slow stable growth, consistent with overall economy • Consistent returns and cash flow • Low number of new entrants • Dominated by a few large companies

  13. Business Cycle Impact • As the economy improves, companies increase capital spending in response to higher demand for products • Leads to expansion in production capacity • Global sector • Significant influence from domestic and international economies • Growth focused in emerging markets

  14. Catalysts & Risks • Catalysts • Europe coming out of their recession • Turnaround in China • Growth in emerging markets • Risks • Lower government spending • Strengthening US Dollar • Uncertainty regarding monetary policy • Slow global growth forecast

  15. Porter’s Five Forces

  16. Economic Analysis

  17. Industrials Drivers • High Correlation to overall equity market • Production & Manufacturing • GDP • Unemployment • Crude Oil • Housing

  18. Industrials & S&P 500 highly correlated 10 Years Industrials S&P 500

  19. Industrials & S&P 500 highly correlated 5 Years Industrials S&P 500

  20. Industrials & S&P 500 highly correlated 2 Years Industrials S&P 500

  21. Industrial Production • Measures real output of manufacturing, mining, and electric and gas utilities • Industrials sector accounts for the bulk of the variation • Manufacturing very soft based on May data. • Excluding motor vehicles, manufacturing rose only 0.1% in May • Capacity utilization decreased to 77.6% in May from 77.7% in April Data source: Haver Analytics

  22. Durable Goods Orders • Reflect new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods • Extremely volatile • Up 3.6% in May • Transportation up 10.2%, making up most of the gains Data source: Haver Analytics

  23. ISM Manufacturing Index • Survey of 300 manufacturing firms: employment, production, new orders, deliveries, inventories • >50 = expanding <50 = contracting currently 50.9 • Strength from new orders and export orders • Weaknesses from employment, inventories, and prices • Slow growth Data source: Haver Analytics

  24. GDP • Revised down to 1.8% from 2.4% led down by personal consumption • Headline inflation at 1.2% • Economic Growth marginally positive in Q1 with low inflation • What will the Fed do? Data source: Haver Analytics

  25. Unemployment Data source: Haver Analytics

  26. Crude Oil – Highly Correlated 5 Years

  27. Housing – Existing Home Sales • Up 4.2% to annual sales rate of 5.18 million, highest since late 2009 • Median price up 8.4% in May to $208,000 mean $255,300 Data source: Haver Analytics

  28. Housing – New Home Sales • Up 2.3% to annual rate of 454,000 • Median price up 8.3% in May to $271,600 mean $330,800 Data source: Haver Analytics

  29. Housing – Housing Starts • We need equipment, tools, and material to build! • Thank you Ben Bernanke! Data source: Haver Analytics

  30. Financial Analysis

  31. Revenue Growth Slow & In-Line with S&P 500 • 5 Year CAGR: Industrials Sector 2.7%, S&P 500 2.5%

  32. Margin Growth Lags S&P 500 • Industrials sector operating margin lags S&P 500 • 5 Year CAGR: Industrials Sector -0.7%, S&P 500 0.9% • Mixed results in net profit margin • 5 Year CAGR: Industrials Sector 2.5%, S&P 500 3.5%

  33. Significant R&D and Capex Spend • Increase in R&D spend as a percent of sales • 5 Year CAGR: Industrials Sector 2.2%, S&P 500 -2.9% • Capital intensive industry, capex as a percent of sales is increasing but trailing S&P on percent growth • 5 Year CAGR: Industrials Sector -0.7%, S&P 500 0.6%

  34. ROE is a Concern, but Rebounding • Industrials sector operating margin lags S&P 500 • 5 Year CAGR: Industrials Sector -2.2%, S&P 500 3.7% • Mixed results in net profit margin • 5 Year CAGR: Industrials Sector 7.9%, S&P 500 -0.6%

  35. Consistent Generated of FCF, Lags S&P 500 • 5 Year CAGR: Industrials Sector -1.1%, S&P 500 23.4%

  36. Valuation Analysis

  37. Industrials Valuation

  38. Industrials Valuation

  39. Recommendation

  40. Recommendation • Currently -234bps underweight • We recommend no change in weighting of industrials • Reasons for concern • Slow global growth • GDP forecasts • Economy is still early in recovery phase • Foreign political uprisings • Low growth potential – valuation suggests sector is inline • Why we may be wrong • Recent housing recovery • Possible energy independence (lower production costs = higher margins) • Faster economic expansion • Consumer sentiment

  41. Questions?

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