On July 16, The Wall Street Transcript interviewed Stephen Tusa, Vice President and Senior Analyst of the multi-industry electrical equipment equity research group at JPMorgan Securities. Key excerpts, including his sector picks, follow:
TWST: What names are at the top of your list?
Mr. Tusa: I have two types of stocks that I'm recommending. The first is a bit more of a safety type of stock. Those stocks would be 3M (MMM), General Electric (GE) and ITT (ITT). Those are three stocks that are high quality, safe earnings stories. The other ones I'm looking at have a bit more economic leverage, but are less expensive that I think investors are mispricing the earnings risk into. Dover (DOV) is at the top of that list, and it would be followed by Rockwell (ROK) and Textron (TXT). I'm also recommending American Standard (ASD), but that's a bit of a different animal. There is a pending spinoff there, and that's more of a portfolio restructuring story. It's a chance to buy a commercial HVAC business that is being underappreciated in the current stock price.
TWST: What's the attraction of a name like Dover?
Mr. Tusa: Dover is a cheap stock, and that's where we start. Dover has had a significant discount to the group, and I believe an unwarranted discount. The concern there is that the business model doesn't work. The company has missed numbers for the last couple of quarters. I think the Street is taking a wait-and-see approach. With the lack of visibility here and no guidance, the Street is uncertain as to what the real earnings base is this year. If they meet the quarter, which I think they will, they are going to start to use their balance sheet to buy back stock - the free cash flow yield on the stock is around 7.5%, which is very positive relative to the group and the stock will readjust to a sector multiple. If you put a sector multiple on next year's earnings, you get to a stock price that's in excess of $60, and the stock is currently at $53.
TWST: What's your interest in Rockwell?
Mr. Tusa: Rockwell is another non-consensus call. We are one of only a few buy ratings here. The bear case on Rockwell is that it's deeply cyclical, tied to business investment. We agree that it is tied to the business investment cycle, but we just don't think it's as deeply cyclical as the Street assumes. Because of its high margins, high return on invested capital and high growth - three things that make up a pretty good high-quality company - it should really command a premier multiple to our group. There is an emerging software story that's going on here too that highlights how much higher tech this business is than just a run of the mill cyclical company. So we are betting that the market is being too aggressive in its discount for cyclicality here. Additionally, we do not think the business investment cycle is going away. We think it's actually going to be just fine for the next couple of years. In that kind of an environment, we think Rockwell can perform well.
TWST: What's it going to take to get investors convinced?
Mr. Tusa: Investors are already being convinced. The stock was at $58 about a month ago and it's now at $70. With every economic data point that we get, it appears as though the US economy is not that bad. In this steady state environment, Rockwell is going to put up some pretty nice numbers that are in excess of the Street. If they do that, we will start talking about the longer-term story and the software angle, which will be the key to driving further multiple expansion.
TWST: How about Textron?
Mr. Tusa: Textron has come a long way. It's now at a point where they need to execute on their industrial asset sales and then turn the bell margin around. That's what's going to get it moving significantly beyond here. There is a great visible aerospace story here that's driving top-tier organic growth and earnings performance.
TWST: The final name you mentioned was American Standard.
Mr. Tusa: American Standard is breaking up. We like the fact they are selling bath and kitchen, and we also like the vehicle control business they are spinning out. The real jewel here is the commercial HVAC business, which is going to be a big part of a standalone company that's left over. Our view on that business is that there are not a lot of assets out there that are as tied to energy efficiency in non-residential buildings as this commercial HVAC business is. We think that is a secular growth story that has tremendous legs over the next few years, and that is why I want to buy ASD now, pre-split.