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The 3rd quarter of trading and the second-quarter earnings season have both started slowly, with guidance warnings, continued flashing lights from Europe, a few decent trading days and some reports that beat low expectations, but also a few notable disappointments. Stocks teetered along this bumpy news and rest mostly flat on the month to date, but the industrial sector (NYSEARCA:XLI) has struggled compared with the S&P as a whole (NYSEARCA:SPY).

(click to enlarge)^INX Chart

^INX data by YCharts

We may have a downward leg or three to go in this correction as the market works off all of its Q1 optimism and knocks all the stuffing out of valuations, to the point where the combination of lowered expectations and better news becomes an elixir for the market (well, that or the wonder drug that is QE3). So while bracing for the loss in paper value this quarter, investors can also prepare a shopping list if they have any cash dry. The aforementioned industrial sector is on its way to the bargain basement, and deals will be had.

(click to enlarge)^INX Chart

^INX data by YCharts

I looked recently at Manitowoc (NYSE:MTW), a crane and food service equipment maker that is a classic cyclical company. In running the comparison, the value of Manitowoc's rival Terex (NYSE:TEX) stood out (as pointed out by a commenter). As long as we're preparing a shopping list, due diligence calls for looking into the company.

Terex is a Connecticut-based machinery company that operates domestically and internationally in five different segments: aerial work platforms (AWPs), construction, cranes, material handling and port solution, and material processing. For the AWP segment the company makes scissor and boom lifts, i.e. moving scaffolds or cherry picker machines, both under the Genie brand. The material handling and port solution consists of Terex's most recent acquisition, Demag Cranes. The formerly-independent German firm, which Terex bought out in a hostile takeover, makes industrial and harbor cranes designed for dealing with lumber or scrap metal, or else for aiding shipping processes in ports.

Each of these segments is tied to an economy that has high demand for construction and materials. The AWP, construction, and cranes segments are directly leveraged to construction, while the remaining two segments have to do more with demand for commodities and shipping. When demand and construction is high, Terex is well-positioned to grow. When those areas slump, well, it can get tricky.

Like many industrial companies, Terex had a strong first quarter, posting an operating income four times greater than the year-prior quarter. The company did especially well in the AWP category, growing into the company's biggest segment by net sales in the quarter thanks to strength in the North American rental market and in Australia. The first quarter was a success even though 63% of the company's revenue was international, with Western Europe providing 28% of the total as Terex's second largest region.

The comparison with Manitowoc mainly comes in the crane business that the two companies compete over. Terex earned 63% of its revenue in Q1 from its main crane businesses (MHPS, constructions, and cranes) and grew those sales 55% from the year-prior quarter, but that number was inflated by the Demag Cranes acquisition - removing that, the growth in these segments was only 5.55%. Manitowoc earned 59% of its revenue from cranes in Q1, with those sales increasing 29.3% from the year-prior quarter. Overall, however, Manitowoc's lead in revenue growth lessens, as it grew revenue by 18% year over year, whereas Terex grew its revenue 16% organically and 45% with its acquisition factored in.

Which leads to the main contrast between the two companies: while Manitowoc has an incongruous but stability-providing foodservice equipment business, Terex is directly leveraged to highly cyclical endmarkets, and its five units go together more obviously. When things are going well in the economy overall, especially on the early part of a recovery phase, Terex is even better positioned to benefit from the upturn - hence, Terex is forecast to grow its earnings incredibly over the next three years. When things go bad, Terex is more vulnerable - the company had heavily negative non-GAAP earnings in both 2009 and 2010 before regaining profitability last year.

(Sources: TDAmeritrade, WSJ)

As of Q1 2012

TEX

MTW

Titan Int. (NYSE:TWI)

Illinois Tool Works

(NYSE:ITW)

Deere Co.

(NYSE:DE)

Caterpillar (NYSE:CAT)

Market Cap

$2.0B

$1.4B

$1.0B

$24.8B

$32.0B

$54.7B

Current Ratio

2.12

1.12

3.21

2.3

2.07

1.33

Quick Ratio

1.19

0.52

2.13

1.72

1.82

0.83

Long Term Debt-Equity Ratio

1.02

3.75

0.81

0.35

2.49

1.86

Quarterly Revenue Growth (Y-over-Y)

44.82%

17.49%

64.90%

3.62%

5.55%

23.41%

Yearly Revenue Growth

47.24%

16.23%

68.59%

12.08%

23.15%

41.21%

EPS Growth (Annual)

NA

49.52%

206%

47.72%

54.06%

49.78%

Estimated Earnings Growth (next 3 years)

126%

74.28%

32.32%

12.05%

10.70%

20.63%

Earnings 2011

0.46

0.38

1.5

3.77

6.63

7.4

Earnings 2012 (Est.)

1.81

0.79

2.6

4.25

8.25

9.69

Earnings 2013 (Est.)

2.74

1.46

2.94

4.72

8.67

11.26

Free Cash Flow 2011

-0.54

-3.7

-0.59

3.24

1.53

4.63

2011 P/E

35.61

28.92

14.91

13.40

11.45

11.07

2012 P/E

9.05

13.91

8.60

11.88

9.20

8.45

2013 P/E

5.98

7.53

7.61

10.70

8.76

7.27

2011 P/FCF

neg.

neg.

neg.

15.59

49.63

17.69

PEG Ratio

0.28

0.39

0.46

1.11

1.07

0.54

Price (as of July 17th close)

16.38

10.99

22.36

50.5

75.94

81.91

Dividend

0

0.08

0.02

1.44

1.84

2.08

Dividend Yield

NA

0.73%

0.09%

2.85%

2.42%

2.54%

(Note: Titan International's EPS annual growth is for 1 year)

There are other grounds to contrast the two companies, as the table above allows us to do. Terex's debt position is significantly better. Its major buy (of Demag Cranes) was significantly smaller and more digestible, even if it was more recent than Manitowoc's buy-out of Enodis PLC in 2008. Terex only barely achieved positive operating cash flow last year after two negative years and fell back into negative cash flow for Q1; Manitowoc had the same near-term results, but stayed positive on a yearly basis through the crisis.

And then there's the valuation that we can see above. While Manitowoc is cheap on a 2013 P/E basis, it is well or even richly valued based on 2012 estimates and 2011 results. Terex is cheap on both 2012 and 2013 results, and extremely so at that. The PEG is miniscule for most of the companies in the above table, but TEX's sinks beneath all the rest.

Terex's more cyclical exposure, maybe combined with better management and more name recognition from Manitowoc, has led Terex's stock to underperform its rival's and rock a little bit more significantly. Manitowoc may be perceived as a safer stock among the two companies:

(click to enlarge)TEX Chart

TEX data by YCharts

Summary

Terex's position has become attractive in the wake of the Demag acquisition. The company has a decent balance sheet, strong earnings visibility, and a cohesive business. The stock is also very attractively priced, having taken a beating from the market overall.

The other shoe on that argument is that Terex may well miss its estimates not only for the coming quarter, due to the recent weakness in the global economy, but over the long term. It's nice to have over 100% growth forecast, but the bar is high for the company, and the market as a trading system clearly does not expect Terex to clear that bar.

It would appear that Terex would be a riskier play that is inappropriate unless one is confident the economy is going to hit a positive long-term cycle. While that may well be the case, in the near term it looks like we are going to slog, which makes Terex relatively and absolutely unfavorable.

If one were to choose specifically between Terex and Manitowoc, however, I think Terex might be the more attractive investment in either positive or negative cyclical settings. If things are going well in the economy as a whole, we've established that Terex stands to gain more than Manitowoc. If things are going poorly, Terex may suffer more from an earnings and cash flow standpoint, but the company also has less debt and a stronger financial position, which puts it at less risk than Manitowoc in a prolonged downturn. If the economy continues slogging along, neither stock is attractive, and a wait-and-see approach might be advisable until the two companies report second-quarter earnings. It's worth watching to see if either company lowers its guidance, or if analysts reconfigure estimates around the results. In any case, Terex is the cheaper stock and has less room to drop, possibly because its earnings are more vulnerable.

The third quarter has been uneven, and there should still be opportunities to buy industrial stocks with strong businesses that are affected by economic and market woes and fears. Terex and Manitowoc both could become attractive plays for patient, long-term, somewhat contrarian investors over the rocky month or two to come. While I didn't expect the numbers and research to bear this out going in, I find that Terex might be the better option, with more upside, more financial safety, and a cheaper valuation all rolled into one package.

Keep the shopping list ready, but bump Terex a little ahead of Manitowoc. It's got more to build with.

Source: Clearing Out A Spot On The Shopping List For Terex