* All data are as of mid-day Tuesday, November 25, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
The Machine Tools & Accessories industry is a major supplier to some pretty big segments of the economy including manufacturing, construction, and individual consumers.
In the simplest of definitions:
Machine Tools and Accessories companies engage in the production and distribution of tools used to manufacture other products in end markets such as the housing and automotive industries. These companies manufacture products such as cutting tools, drills, milling machines, wrenches, bearings, and other related components.
As such, the industry is very responsive to the production and housing cycles, and some companies within the space even get a little boost from the holiday gifting season, as in the case of Stanley Black & Decker.
Here's a brief look at what the largest three U.S. companies in the industry specialize in:
- Stanley Black & Decker, Inc. (NYSE: SWK), headquartered in New Britain, Connecticut, provides power and hand tools for industrial and personal use, mechanical access solutions, and electronic security and monitoring systems. Its tools include drills, impact wrenches and drivers, grinders, saws, routers, sanders, lawn and garden products, planes, hammers, demolition tools, knives, saws, chisels, tool boxes, sawhorses, and storage units. It also offers engineered storage and fastening products, custom pipe handling machinery, joint welding and coating machinery, weld inspection services, and hydraulic tools and accessories. Its security products and systems include alarm monitoring, video surveillance, fire alarm monitoring, systems integration and maintenance, medical cabinets, infant protection, pediatric protection, patient protection, wander management, fall management, emergency call products, automatic doors, commercial hardware, locking mechanisms, electronic keyless entry systems, keying systems, and tubular and mortise door locksets.
- The Timken Company (NYSE: TKR), headquartered in North Canton, Ohio, offers mechanical components and bearings to engineers, manufactures, and construction companies. Its products include bearings, seals, lubrication devices and systems, power transmission components, engineered chain augers, and sensors used in spacecraft, robotic vehicles, and motion control equipment. It also has an aerospace division that supplies bearings, helicopter transmission systems, rotor-head assemblies, turbine engine components, gears and housings. Its maintenance and service division handles complete engine overhaul on industrial machinery, aerospace bearing repair, component reconditioning, as well as parts and maintenance services to manufacturers of off-highway equipment for the agricultural, construction, and mining industries.
- Kennametal Inc. (NYSE: KMT), headquartered in Latrobe, Pennsylvania, manufactures and supplies tooling, engineered components, and advanced materials used by the manufacturing sector such as cemented tungsten carbide products, super alloys, coatings and castings. It serves a broad range of industries including aerospace, defense, transportation, general engineering, and machine tooling, with many of its products going into engines, airframes, automobiles, trucks, ships, and various types of industrial equipment. It also has an infrastructure division which caters to the energy and earthworks sectors including oil and gas, power generation, food and beverage, chemicals, mining, highway construction, and road maintenance.
As such, the Machine Tools & Accessories industry has been ratcheting up the charts during the economic recovery since early 2009 thanks to a pick-up in industrial, manufacturing and construction, as noted in the graph below.
Where the broader market S&P 500 index [black] has risen some 205% and the SPDR Industrials Sector ETF (NYSE: XLI) [blue] which the industry belongs to has risen 275%, Kennametal has climbed 180%, Stanley [beige] has gained 323%, while Timken [purple] has simply hammered its competitors with a rise of 455%.
On an annualized basis, where the S&P has averaged 36.18% and XLI has averaged 48.53%, Kennametal has averaged 31.76%, Stanley has averaged 57%, while Timken has averaged 80.29% per year!
Looking forward, the Machine Tools & Accessories industry is expected to continue benefiting from the ongoing economic recovery of the manufacturing and construction sectors as tabled below, where green indicates outperformance while yellow denotes underperformance.
Over the immediate quarters, the industry's earnings are expected to outgrow the broader market's average growth at a rate of some 3.33 to 7.86 times, cooling a little to 1.21 times in 2015, before rising up to 1.44 times averaged over the next five years.
Zooming-in a little closer, the three largest U.S. companies in the industry are all expected to underperform the broader market near term, with Timken shrinking in the current quarter before making up the loss plus more next quarter.
As the economic recovery continues over the longer term, all three companies are expected to outgrow the broader market, with Timken holding the lead in 2015 and over the next five years.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Kennametal posted the greatest revenue growth year-over-year, while Stanley posted the slowest growth.
Since Timken's earnings growth is not available, the metric will not factor into the comparison, though it is worthy to note that Stanley's earnings growth surpassed Kennametal's by a significant degree.
Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Stanley operated with the widest profit margin while Timken operated with the widest operating margins. Meanwhile, Timken and Kennametal contended with the narrowest margins from profits and operations respectively.
Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, Timken's management team delivered the greatest returns on assets and equity, while Stanley's and Kennametal's teams split the worst returns between them.
Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Kennametal provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Timken's DEPS over current stock price is lowest.
Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Kennametal's stock is the cheapest relative to forward earnings and company book value, while Timken's contains the most value relative to 5-year PEG. At the overpriced end of the scale, each company's stock ranks worst in one of the ratios.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Stanley offers the highest percentages of earnings over current stock price for the current quarter, while Kennametal offers them for the remaining periods. At the low end of the scale, Timken offers the lowest percentages for the current quarter, while Stanley offers them for next quarter and 2015.
Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Stanley offer the greatest growth in the current quarter, while Timken offers it the rest of the way. At the slow end of the spectrum, Timken offers earnings shrinkage in the current quarter, where Stanley delivers the slowest growth in 2015, while Kennametal delivers it for next quarter and over the next five years.
Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Stanley's stock offers the least upside potential and greatest downside risk, while Kennametal's offers the greatest upside and Timken's offers the least downside.
It must be noted, however, that Timken's stock is already trading below its low target. While this may mean an increased potential for a sharp move upward, it may warrant a reassessment of future expectations.
Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Timken is best recommended with 3 strong buys and 4 buys representing a combined 63.63% of its 11 analysts, followed by Stanley with 1 strong buy and 7 buy recommendations representing 42.10% of its 19 analysts, and lastly by Kennametal with 3 strong buy and 1 buy ratings representing 26.67% of its 15 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Timken with a fully stocked tool kit, outperforming in 16 metrics and underperforming in 7 for a net score of +9, followed far behind by Kennametal, outperforming in 10 metrics and underperforming in 8 for a net score of +2, followed further behind by Stanley with some pretty badly banged-up thumbs, outperforming in 4 metrics and underperforming in 15 for a net score of -11.
Where the Machine Tools & Accessories industry is expected to outperform the S&P broader market substantially this and next quarters, modestly in 2015, and moderately beyond, the three largest U.S. companies in the space are expected to underperform the broader market near term before outgrowing in 2015 and beyond, with Timken leading the way.
After taking all company fundamentals into account, The Timken Company simply drills its competition into the floor, given its lowest stock price to 5-year PEG, highest cash / lowest debt / highest revenue over market cap, widest operating margin, highest returns on assets and equity, highest future earnings growth overall, highest dividend, best mean and low price targets, and most analyst strong buy recommendations - decidedly winning the Machine Tools & Accessories industry competition.