Industrial stocks keep wheels turning
A closer look reveals that not all have a rosy outlook, researcher says
Boosted by Donald Trump’s election, industrial stocks have been on a tear.
That makes it difficult to ignore such names, but the higher their prices go, the more frightening it is to embrace them.
“They are all acting terrifically,” said John F. Collopy, director of research for the Oshkosh brokerage firm Carl M. Hennig Inc. “The fundamentals on a lot of them are not particularly appealing, but that doesn’t appear to make any difference right now.”
Collopy has been sorting through the Wisconsin-based industrials by starting with an evaluation of how efficiently they deploy capital.
The tool he uses is an equation: total capital divided by EBIDTA (earnings before interest, depreciation, taxes and amortization). The result tells him how much capital each company needs to make a dollar of profit.
The amount of capital Wisconsin’s publicly traded industrial companies need to make a dollar of profit ranges from $3.15 to $8.04, Collopy said. This is an important metric that companies use to determine whether to do things like make acquisitions or buy big pieces of equipment, he added. But for investors, it’s another tool to help evaluate a company’s merit.
These three companies fare particularly well in Collopy’s capital efficiency measure, as well as in other financial ratios, he said. There is a risk to all of their stocks if the presumed positives associated with Trump’s election fail to materialize, and they could suffer if there were a market sell-off, he said.
A.O. Smith Corp. (AOS), Milwaukee, makes and markets water heaters, boilers and purification equipment to the residential and commercial markets.
A.O. Smith has the best capital efficiency in the state; it uses just $3.15 of capital for each dollar of profit, Collopy said. The company has “terrific” return on equity of 22% and a return on invested capital of 17%, Collopy said. Analysts estimate the company will earn $1.85 a share this year, a healthy increase from $1.58 a share in 2015, he said.
A.O. Smith’s measurable growth is coming almost exclusively from China, Collopy said. If China’s economy softens, investors could treat the company’s shares harshly, he said.
However, the counterargument to that is that A.O. Smith sells a consumer goods product; that part of the Chinese economy has not been softening like the industrial sector, Collopy said.
These shares have a 52week range of $30.15 to $51.49. He says the perfect entry point for buying them would be $43 or $44 a share — about 10% below their current price.
Snap-on Inc. (SNA), Kenosha, makes and markets tools, equipment, diagnostics, and repair information and other systems for professional users worldwide.
Snap-on uses $3.93 of capital for each dollar of profit, Collopy said. The company has a return on equity of 21% and a return on invested capital of 16%, he said. Analysts estimate it will earn as much as $9.20 a share this year, up from $8.21 a share in 2015, he said.
Snap-on sells many of its tools on credit to mechanics at auto dealers, repair shops and factories.
“If interest rates exploded, they might have a problem keeping volumes up because of financing costs,” Collopy said. Also, a slowdown in the automotive market would hurt the stock, he said.
These shares have a 52week range of $133.09 to $177.86. Collopy says he would aggressively buy these shares if they fell into the low $160s.
Rockwell Automation Inc. (ROK), Milwaukee, provides industrial automation, power, control and information systems.
Rockwell uses $3.37 of capital for each dollar of profit, Collopy said. It has a return on equity of more than 34% and a return on capital of more than 23% — both “excellent” numbers, Collopy said. Its shares have performed very well during the last three months, particularly since the presidential election, he said.
Rockwell had a year over year decline in earnings in fiscal 2016, the first in several years, Collopy said.
“It’s not unusual in this economy to have a down year, but Rockwell’s recovery appears to be underway,” he said.
Rockwell is dependent on industrial and automotive spending, so it would suffer if the great expectations for the industrial sector fail to materialize, Collopy said. However, its exposure to highergrowth sectors like life sciences and information technology would balance that to some extent, he said.
These shares have a 52week range of $87.53 to $139.64. He said he would buy them if they fell to $127 a share or lower.