The ongoing strength in the United States ISM Manufacturing index sends out strong signals that industrials are headed for a period of elevated capital spending, as these businesses gain more confidence and look to spur reinvestment. The Federal Reserve's recent decision not to start a stimulus taper (at least not right now) has been construed by investors and concerned stakeholders to mean that either the Fed is worried that Congress might actually bollix things up in the near future, or that the recovering economy is still too weak to be taken off life support, or both.
Capital spending went to the dogs ever since the global economic crisis struck. There is now an urgent need to upgrade or replace machinery that's a bit long in the tooth. The ISM's Purchasing Manager's Index (PMI) has already capped its two-year acme. A 50+ reading is taken as a positive sentiment.
This trend suggests the industrial sector is going strong, with industry leaders recording robust growth. Schwab (NYSE:SCHW) director of sector and market analysis has given an ''outperform'' rating on Technology and Industrials sectors in the next six months. These two sectors are the main beneficiaries of increased corporate spending.
Industrials have been recording an impressive run of late. A peek through the Industrials Select SPDR ETF (NYSEARCA:XLI) that tracks the S&P 500's industrial stocks says that the sector is up 27% over the past one year, compared to just 17% for the wider S&P 500 index. Ben Bernanke's late May taper talk sent the message time was ripe to start focusing more on economically sensitive sectors, which led to the industrials sector taking off and outperforming the defense sector.
Industrials still cheap
According to the S&P Capital IQ, the S&P 500 industrial sector has an average PE ratio of 15.8. This PE level is just slightly above the 15.6 PE ratio for the entire index. It is also a lot lower than the consumer discretionary average PE ratio of 19.6, and the 18 average PE reading for the consumer defensive and materials sector. The forward PE ratio (2014) for the industrials sector is 13.8, which is lower than the entire S&P 500 expected forward PE of 14.
United technology posts robust revenue growth
United Technologies (NYSE:UTX) beats its peers by a mile when it comes to revenue growth. United Technologies provides high-technology products and services to the global aerospace and building systems industries. The firm has a strong 11.23% revenue growth TTM, compared to its closest rival Boeing (NYSE:BA) with 5.15%. Union Pacific (NYSE:UNP) comes in third with a 2.74% revenue growth TTM while 3M (NYSE:MMM), one of the leading industrial conglomerates, rounds off the top five Industrial Select SPDR holdings with a 2.24% revenue growth TTM.
It should be borne in mind that United Technologies' impressive growth came against a backdrop of an industry starved for top-line growth for years.
I know many readers will probably wonder why I have not included General Electric (NYSE:GE) in my analysis. General Electric is the largest holding in the Industrials Select SPDR ETF. Although a lot of GE's business is found in its industrial operations, its finance arm is, however, a significant contributor to the firm's bottom line. General Electric derived 44% of its revenues and 33% of its 2012 profits from the GE Capital arm. The firm's management has been working hard to refocus more on the company's core industrial line. There are ongoing rumors that GE might spin off its consumer finance arm in 2014. However, the firm will have to put in a lot of work before it can be recognized as a pure industrial play. It would not be fair to directly compare GE with pure play Industrials such as UTX.
United Technologies has received a strong Buy rating from The Street Ratings. The Leuthold Group considers the Aerospace and Defense industry where United Technologies belongs as a good investment based on attractive valuation and strong price momentum. The firm recorded better-than-expected second-quarter earnings of $1.65 per share in the second-quarter beating consensus estimates of $1.58 EPS. UTX recorded an impressive 15.9% Y-o-Y revenue growth with $16 billion in revenue in the quarter, missing out on the consensus revenue estimate of $16.41.
United Technologies' strength is clearly evident in multiple areas such as revenue growth, robust net income growth, solid price performance and a strong financial position characterized by reasonable debt levels.
United Technologies is currently trading at 109.36. Several financial analysts have raised their PT for UTX. UBS AG has a Buy rating on the firm with a new $122.00 PT for the firm, up from $105.00. Cowen and Company have an outperform rating on United Technology and raised the firm's PT from $112.00 to $120.00. Sanford and Bernstein have also raised UTX's PT from $98.00 to $120.00. Four investment analysts have a Hold rating while fifteen have a Buy rating on the stock. The average $120.00 PT suggest a 9.73% potential upside from the current price.
UTX combining internal businesses
United Technologies announced on Monday, Sept. 23, 2013 that it is planning to combine its climate and elevator business segments. The company decided on the rather strange decision based on trend it picked up in emerging markets such as China.
United Technologies CEO Louis Chenevert said that the new amalgam will help the company position itself better to take advantage of the lucrative growth opportunities that emerging markets provide. United Technologies revealed that it had recorded a 39% growth in orders from the Chinese market.
The general trend of strong growth driven by growing demand for industrial products and increased capital spending will help industrials such as United Technologies to register stronger revenues in the coming quarters and years. UTX has an impressive presence in the all-important emerging market of China and is making strategic moves to take full advantage of the existing and emerging business opportunities. The stock has received a strong Buy rating by 15 out of 19 analysts with an average 120.00 PT. Times can only get better for United Technologies and its investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.