UBS Investment Research recently published a report entitled “US Research” on December 30, 2011. The report isn’t publicly available, but we will discuss its main points. In the report, they have listed their top stock ideas for 2012. The list includes UBS’s most-preferred and least-preferred stocks from a wide array of sectors. In this article, we will discuss the least-preferred stock ideas for the Industrial sector. This is the second of two articles.
American Railcar Industries (ARII) designs, manufactures and sells hopper and tank railcars. UBS has given the company a sell rating. UBS is also of the opinion that the consensus earnings estimates for the company are too high coupled with the unjustified current valuation given the earnings power of the company. American Railcar is trading at a premium to the market despite railcar stock usually trading at steep discounts. Due to lowered market volumes, there is a significant risk that the next peak earnings will be below the 2007 levels. The company is also facing a competitive environment, challenges in pricing and costs, and excess manufacturing capacity. Shares of American Railcar Industries are currently trading at $27 per share and are expected to drop to a price target of $17 per share. According to UBS, the company is trading at 18x the 2012 earnings. The company generated returns of 8.4% in 2011.
Layne Christensen Company (LAYN) provides drilling, water treatment and construction services to water infrastructure and mineral exploration markets. The company has been given a neutral rating by UBS due to its exposure to the water markets which face funding problems. Water accounted for almost 50% of the company’s profit last month but is facing challenges on account of weak housing markets and tight budgets. The low price of natural gas coupled with the company’s investigation relating to a potential violation of the Foreign Corrupt Practices Act is also why UBS has placed the company in its least-preferred list. Layne Christensen also has significant exposures to mining, leading to outsized risks of slowing in China. Shares of the company are currently trading at $24.5 and are expected to reach a price target of $24 per share. The price target has been calculated with a 4.5x enterprise value to EBITDA multiple.
Meritage Homes Corporation (MTH) designs and builds single-family attached and detached homes. UBS has given the company a neutral rating and believes that Meritage Homes is in a position for an eventual recovery. On the other hand, the company is not in a position to increase earnings per share or its book value quickly enough to justify its current valuations. Meritage Homes also faces a lot of geographic risk and UBS expects the housing sector to recover slowly in the upcoming years. Shares of the company are currently trading at $24.4 and are expected to go south of $19. UBS is of the opinion that the company is well-positioned but current valuations have been exaggerated. Meritage Homes generated returns of 5% in 2011.
The Manitowoc Company, Inc. (MTW) engages in the manufacture and sale of cranes and related products. It has been given a sell-rating by UBS. Due to the company’s highly leveraged finances, UBS believes that investors may prefer other stocks in the global crane market as opposed to Manitowoc. Macro uncertainties are likely to cause its earnings per share to be revised downwards after some delay. Also, the Manitowoc Company has recently experienced an employee strike and supplier delivery issues. The biggest risk that the company faces in the short-term is a decrease in the number of crane orders. Shares of the company are currently trading around $10 and are expected to reach a price target of $12 per share by the end of 2012. The estimated price target is based on 8x 2012 enterprise value to EBITDA ratio. Billionaire David Tepper is also bearish about Manitowoc. Appaloosa Management sold its entire stake in the company during the third quarter.
Potlatch Corporation (PCH) is a real estate investment trust that owns and manages timberlands. The company has been given a sell-rating by UBS because its core timber markets are not expected to achieve sustainable recovery. The Asian demand for U.S. based timber is likely to be weaker in 2012, negatively affecting the company. Potlatch’s decision to lower harvests is also likely to decrease its profits. With a growing likelihood of land prices being driven upwards, Potlatch may become a take-out candidate. Shares of the company are currently trading at $31.5 and are expected to decline to $28 per share. This price target is based on 10x the 2012 enterprise value to EBITDA ratio. Mason Hawkins had $86 million invested in PCH at the end of September.
Watsco Inc. (WSO) distributes air conditioning, heating, refrigeration and related parts in the U.S. It has been given a sell-rating by UBS due to its exposure to the limited growth potential in its consumer and residential end markets. Despite the weak top line growth outlook, low operating margins, and a relatively low return on invested capital, the company’s shares are trading at 21x price-to-earnings ratio which UBS believes is hard to justify. UBS is also of the opinion that the company’s 10% operating margin goal is hard to achieve and a merger activity is likely to be accretive to the value of the company. Shares of Watsco are currently trading at $67.6 and are expected to reach a price target of $49 per share. The price target is based on 16x 2012 price-to-earnings ratio. The company generated returns of 4.6% in 2011. Merchants’ Gate Capital has the largest position in Watsco among the 350+ hedge funds we are tracking.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.