Today’s markets maintain a level of anxiety that another leg-down is coming, namely the notion that we may revisit our former lows of March. As the more bullish investors continue to invest in financial and IT names, it would seem that the vast majority of market movers are taking profits off of the table in the industrial sector of the economy. But while the money seems to be rotating out of the early-cycle names that seem to have gotten ahead of themselves, many of which are up considerably from the bottom, I reiterate that there remains significant opportunity in cyclical-aerospace.
Over the length of the past stock market rally, industrial names enjoyed tremendous gains from the March lows. As one of the sectors to bounce back the strongest, many names like 3M (up over 40% from its lows) (MMM), General Electric (popped over 115%!) (GE) and Caterpillar (over 80% increase) (CAT) have been the darlings of the bulls. Some of the largest gains off of the 2-month stand have been made in industrial names… while similar gains were to be had in financials, information technology, energy and materials. If all of these groups have momentum, why has a shadow been cast on industrials?
Financials have valuation on their side. Investors feel that because names in the sector have traded at “$X” in the past, they deserve to rebound strongly and command a better trade in any upward push. Energy and materials are both tied to the commodity markets that, again, many have felt are lying too low… even in the current state of things; aggressive ag./oil & gas traders are going to pull this group higher. Then we have IT, which is the darling of the rally that many think should be leading the pack higher. Finally we come to industrials. With this group, rather than suggest a higher “worth,” most analysts are downgrading names on valuation calls saying that they have “gotten ahead of themselves” (the subject of this thesis).
I wouldn’t disagree, but there are overlooked names in the aerospace market that are escaping public eye and could be leaders in the next leg-up!
One group we are very bullish on here at Bullish Bankers is aerospace. This late-cycle play could pay out in spades if the markets turn. As opposed to the early-cycle names that took advantage of the earlier rally because of their cyclical nature, the major aerospace conglomerates have been left out of the party… and continue to present artificially-low valuations as of today’s close. With the markets getting “no worse,” the theme continues to be improvement in the second derivatives, which suggests margin improvement and an eventual recovery in the group.
In 2010 in particular, many airlines are projected to return to profitability. With jet fuel costs stabilizing, the negative effects of hedging (specifically over-hedging in the commercial markets) could finally work their way through the system. Previously frowned upon business jet spending seems to be seeing renewed buying interest according to representatives from General Dynamics’ [GD: 56.90, -0.14 (-0.25%)] Gulfstream Jet unit.
The most important indicator to note? Airplane manufacturers are running out of spares in their inventories at alarming rates. As we continue to see inventories drop, I anticipate a quick rebound in buying power with the primary beneficiaries being the parts-producers we will now name. With flight hours (yoy) improving in China and around the developing world… it shouldn’t be long before international aerospace conglomerates begin to see their patience pay off.
Below are three industrial conglomerates that will benefit from a turnaround in the aerospace market, as well as a broad market rally. When pit against their industry brethren, the bounce from early-March lows has been relatively weaker than we have seen from the sector.
Honeywell is my top pick for getting into a bullish position now. At current levels, Honeywell offers a meager 9.2x multiple, despite their strength and conservative management. Estimates have been dropped by the firm to a level that they should be able to beat next quarter should nothing improve, while any uptick in the economy should allow for an easy beat. In addition to aerospace, HON has a nice exposure to automotive markets with their Turbo Technologies unit… and volumes seem to be bumping along at trough levels, which could produce much upside to current levels. They’ve shored up their balance sheet behind CEO David Cote, who actually said he was “embarrassed” by the EPS outlook. Adding to this, Honeywell has a great stake in Asian markets, which should lead aerospace beyond the current trough. Clearly, management feels they can do better, and we hold an upbeat view on shares even in a rough time.
Ametek is a virtual private equity firm when you get right down to it. They are labeled a small electrical components provider (among other things), and have direct ties to European aerospace markets. However, one great feature of this mid-cap international conglomerate is that they are a growth company by way of “bolt-on” acquisitions. Despite slow M&A markets, AME once again completed dozens of acquisitions in 2008 and is on the prowl in 2009. While the company released “in-line” earnings for the most recent quarter, a cautious drawback in guidance sent investors running for the hills. However, their current trading range severely undervalues the future prospects of this bull market poster child… and they remain one of the few with a PEG under 1 (industry average is 1.25x). The story is still here, and I like shares at $31.
Boeing has been a name which has been picked up by the likes of Goldman Sachs (recently upgraded) and other investment firms. However, the market has yet to give Boeing the benefit of the doubt behind their infamous 787 Dreamliner. Now, it seems that when CEO Jim McNerney claims that the heavily-delayed plane “will fly in June,” he is speaking the truth. Though this has been said time and time again, only to get pushed back, a successful first test flight has this stock on the hearts and minds of investors. Making a quick trade in anticipation of this June release could be a great short-term move, though I like the company for the long run as well. Defense spending remains strong; though there have been cutbacks, Boeing now has something that they didn’t have before: ample financing for interested customers. With this in mind, the uptick in aerospace will see a trade executed for Boeing, while shares are still being pulled down from the Dreamliner and defense budgeting.
The industrial sector commands many attractive valuations while hedge funds take profits off of the table from earlier-cycle plays. Please note that there are quite a few opportunities available in the sector. However, the aerospace market has seen a unique underperformance to the broad sector that we feel should soon show signs of reversal.
Disclosure: The mutual fund that this author is associated with is long AME.