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Pulse Check On Industrials: Q1 Valuations Rich

Apr. 13, 2018 4:26 PM ETBA, CAT, CMI, ETN, GE, HON, ITW, LMT, MMM, TWI, UTX, WM11 Comments


  • While not a large cap investor, keeping an eye on growth, trends, and management commentary from the biggest firms in the industry help guide small cap decision making.
  • Making those efforts easier, automated heat maps can help provide cross-sector comparisons on which areas have stronger sentiment and value.
  • Top 10 bellwether firms listed. Sell-side analysts have their opinion, but which ones are buys and which ones are sells?

While not predominantly large cap focused in my research (smaller firms are the niche in Industrial Insights) the big names in industry are incredibly important. Highly cyclical, tracking trends in the larger companies within the industrials sector can often point to bellwether indicators within the space. While buying opportunities are often few and far between in larger companies due to greater market coverage and excellent liquidity – more eyes means less disconnects – efforts here are still worthwhile. With only so many hours in the day, constant deep dive due diligence across most of these companies on a continuous basis is a tough undertaking. Automation helps greatly. I personally use heat maps, updatable on the fly by tweaking assumptions, which can often bring some quick insight on sectors of the market rotating out of favor. This finger on the pulse of major firms, can indicate areas of the market that have opportunity.

Giving an example of putting this to work, Titan International (TWI) remains a favored small cap pick. The tire and wheel manufacturer relies heavily on new equipment sales in heavy equipment. An unjustified sell-off in the summer not driven by market fundamentals (overall outlook for key customers Deere and Caterpillar suggested otherwise) led to a great occasion to add shares on the cheap:

Titan International still trades at a deep discount to intrinsic value today. While not everyone wants to invest in smaller firms, heat maps can still provide context across the sector on where to direct capital (or at least dedicate greater research) to where it will generate the greatest risk-adjusted returns over the long term. Personally I stay deeply in tune with ten large cap industrials to track trends in areas of growth and overall market sentiment: Boeing (BA), 3M Corporation (MMM), General

Note: Members of Industrial Insights community receive access to actionable research ideas like this one frequently. Value Investor’s Edge is our sister service that shares in top tier financial content. Consider joining two of Seeking Alpha’s most premier services to receive valuable investment analysis that is not publicly available.

This article was written by

Michael Boyd profile picture

Michael Boyd is an energy specialist with a decade of experience in both the investment advisory and investment banking spaces, with stints in portfolio management, residential mortgage-backed securities, derivatives, and internal audit at various firms. Today, he is a full-time investor and "independent analyst for hire.”

Michael leads the Investing Group Learn more.

Analyst’s Disclosure: I am/we are long TWI. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (11)

Michael Boyd,

Since you are an investor in TWI, maybe you know why they are losing money? My interest is simply this; prior to 1978 we Mfg. tires like these for companies like Caterpillar and they were the most lucrative things we sold with Goodyear unwilling in most cases to meet the requirements of the heavy equipment makers.

So they pay a 1/2 cent per quarter dividend on a ~$12 share? I looked through their 160 page catalog online so I can see exactly what kind of tires they are selling, insofar as to whom and for what applications. Start-up and tooling costs aside, these are very high value-added tires and markets. Only a lack of volume, poor distribution/marketing and/or undercapitalized start-up or poor management could cause losses aside from cyclical nature of Commercial, Farm/Forestry, Mining, and Excavation markets. Something is missing in this story.
Michael Boyd profile picture
I think you pegged it pretty well, cyclicality. Farmers simply don't have the cash for new equipment. A lot of them bought new in 2011-2014 when they were making double the money per bushel of corn (similar trends across most agriculture). With crop prices in the tank, they've been deferring maintenance spending on tires as long as they can. Tires ain't cheap; combine tires going for $3,000+ a piece isn't unusual as you know. That's quite a bit of money for even larger farms. Unfortunately heavy equipment spending in mining sectors (where tires cost even more) is also in the tank at around the same time. There is likely a little tailwind from replacement market as I think individuals have differed spending as much as they can at this point.

In 2017, excluding some changes in working capital TWI was pretty neutral in terms of free cash flow. If you think commodity pricing will improve it's a pretty good company at current levels in my view.
Michael Boyd,

I was very young when my dad retired from the Tire Industry after being drafted in the form of being an Emancipated Minor after my Grandfather had a massive Heart Attack following a giant Urban Tire 🔥 in a new building with insurance issues. Yet I can recall him filling the requirements of Caterpillar's Mining Tire specifications which were inflated with Anti-Freeze rather than Air for center of gravity issues. Individual tires were F.O.B. New Jersey at as much as $5,000 per unit and minimum orders were set in carloads (rail).

Those tires went to either Caterpillar or the Mines and Caterpillar always stated their requirements and when Goodyear didn't feel like the order was worth it was pretty easy to "work under Goodyear's Umbrella". Meaning the prices set by Goodyear for similar types and capacities, including ply and CVC (specific synthetic rubber compound) were easily estimated and costing was an easy task for our family's manufacturering business. The number of units required is usually well understood and estimated so it was simply a question of if their was a contractual number of machines being made for a reasonable contract to be offered. The 🔧 ing for Special Orders usually required a sizable upfront payment from the equipment maker and a few times even by mines with large inventories of Capital Intensive, replacement cost prohibitive Off-Road equipment. Farming/Forestry Tires were more easily and cheaply made, but there were a lot of auxiliary types for implements, low speed, low-platform trailers and unusual Front Tires for Farm/Forest tires that were designed for Mud, Flotation or Utility use. The last category was the one that we tried to use or use with CVC or Tread Design modifications for a wide range of aftermarket uses.

The point is, without getting into wheels and other multi-application products. Cycles the effect 🚜 implements and special application tires, especially with a direct link to Goodyear's Distribution for O.E. and Aftermarket Sales should NOT pose insurmountable cyclical issues because those cycles are both not acting in concert with each and other and not without the benefit of the O.E. Mfg. and Goodyear for financial, distribution and planning support. The overlapping of inelastic and elastic demanded products Types, in itself removes a great deal of the downside risk.

I spoke with my dad about this at length over the years. So I didn't have all this industrial experience but I saw it going on in the 70s as a child and my dad has spoken about it often over the years.
I liked the 🔧 and 🚜 symbols you put in. Reminds me of the "Colorforms" you liked so much when you were a child.
Are We Headed For Bear Country?

Found your write-up very insightful. It does look as though actively managing towards secure sectors and individual companies will become increasingly important as the upward creeping interest rates create an increasing headwind. Of the companies mentioned in the article, we've been adding Eaton and we sold off MMM at $255 to yet again buy it back at ~$215 last week. Bearish sentiment for MMM is curiously quite different from GE's Bearish sentiment. A year or 2 ago it took 5-6 shares of GE to Buy 1 MMM and now, after MMM's largest share price reversal in a decade it takes ~15 shares of GE to Buy 1 MMM and MMM has a higher Market Capitalization than GE for the 1st time that I've been aware of and I do recall 2007-2009.

When Did A Recovery Occur?

In any event, recession is a dirty word, but with both interest rate hikes and recently higher Energy prices that can both be lowered quickly by market shocks, the landing doesn't have to be a terribly hard one. But it could be with the kind of political Brinksmanship that's been played lately with "other" people's consequences.

In my opinion, however, consumer spending, especially discretionary spending has never recovered from "The Great Recession" which still seems to be lingering and has left a large well of untapped "Pent-Up Demand" across many sectors. Just look at the average age of American cars! Historic Plates are almost fitted to cars in daily use! So: Either this lower standard of living is becoming the norm or there is an ultimate recovery that we have yet to experience. I am hoping for the later because the country can really use an overall lift.
Thanks Michael, for another interesting lesson in investing. I do agree that CMI and UTX are the best picks in the bunch at this point, by far.

ITW is going to run out of gas suddenly in my opinion, when is hard to guess but I wouldn't touch it until it does. ITW's share price is padded heavily by employees buying the stock in there retirement plan. Also, the 80/20 business model is too often abused by business managers that stretch their divisions to paper thin, squeezing big prophets for a while, but creating huge disappointments at some point.
easindc profile picture
Read your post of April 15 on ITW. Fantastic call anticipating the stock falling off a cliff only days later. I hold a small position and I’m curious if the stock ‘reset’ means, after a base building, will the stock recover? Your thoughts? Thanks, EAS
Hi easindc: This is a long answer and I only have a few minutes. I'm not a fan of the 80/20 business model, I think it's a Fascist business model that breeds dishonest and creates a hostile business environment. In my opinion it should be taxed and regulated much more. It too often, and I wish to underline the too, circumvents free market capitalism and creates an environment where individual management set a horrible example for hourly employees, it creates a bully dishonest society. This kind of business is destroying American civil society.
valuinvstr99 profile picture
Michael Boyd
Regarding CMI, you say, "Deeply cyclical and the quintessential contrarian play....". Please elaborate on where in the cycle CMI is at and provide supporting data. You also say, "Growth is still on the horizon....". How far away is the horizon, the contraction of growth? Stocks are frequently, correctly labeled as cyclical without discussion of the cycle. The fact that a stock is cyclical is not nearly as meaningful to the investment decision as knowing where it is in the cycle. Frankly, I struggle with identifying cycles.
Michael Boyd profile picture
Cyclicality is, of course, reliant on what your view of future earnings will be. The market has been a bit bearish on CMI's future business prospects since the weak initial guide in 2015; the company has beat earnings expectations (despite analyst target hikes) consistently since then, with the sell-side about 10% too low going into the most recent quarter on their expectations for 2018 (management guide vs. their forecast).

The trucking market in the United States has been extremely solid lately, both off highway and on highway. Even though I think the market is being too bullish on 2018/2019 GDP forecasts, Cummins likely does better than the market in my opinion.

For what it's worth, I'll probably be as high as 30% short by the end of the year; I don't see 2H 2018 and 2019 as likely to be solid years for S&P 500 returns. My buy recommendations here are relative performance to the rest of the market.
pro8 profile picture
Of the ones you article refers to my preference would be ETN . UTX looks interesting and MMM a close 3rd
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