"Naturally, idiosyncratic influences vary by company, but broadly speaking, we suspect rich industrials-sector valuations reflect healthy macroeconomic conditions and related optimism," the Dec. 31 report said. "Economic tailwinds have supported decent demand and pricing in most industries. Firms have also become leaner and more efficient since the 2008-09 downturn, providing fertile ground for incremental operating leverage and margin gains. In many cases, we suspect investors are extrapolating these positive operating trends out over the long run."
Trucking, airlines, truck manufacturing and auto dealers are among the most expensive sub-sectors, ranging from 16% to 43% overvalued, Morningstar notes. Companies with valuations that "aren't quite as lofty" include third-party logistics firms, railroads, and business services.
"Despite generally rich valuations across the industrials space, however, some pockets of value still exist," the report said.
TheStreet paired Morningstar's investment perspectives on the six stocks with ratings from TheStreet Ratings, its proprietary research tool, to give an added perspective on the stock picks.
TheStreet Ratings projects a stock's total return potential over a 12-month period including both price appreciation and dividends. Based on 30 major data points, TheStreet Ratings uses a quantitative approach to rating stocks. The model is both objective, using elements such as volatility of past operating revenues, financial strength, and company cash flows, and subjective, including expected equities market returns, future interest rates, implied industry outlook and forecasted company earnings.
Check out which industrials stocks are Morningstar's best picks. Note: not all of Morningstar's picks are also rated by TheStreet Ratings.
2014 stock return: -23.2%
AGCO Corporation manufactures and distributes agricultural equipment and related replacement parts worldwide.
Morningstar Rating: four stars (out of five), $55 fair value estimate
Morningstar says:We see an upside opportunity in out-of-favor agricultural equipment manufacturer AGCO. Approximately 25% of revenue comes from the high-profile North American agricultural market, which is suffering from a steep drop in crop prices. While North American tractor sales will decline in 2014 and 2015, AGCO's grain storage and animal feed business, GSI, should do well as farmers buy grain silos to store crops for a more robust market. Additionally, 2014 was good for livestock farmers, who are spending profits on GSI's feed equipment.
The South American business should also do better in 2015. A 2014 delay in renewing Brazil's equipment financing subsidy program caused a 20% decline in AGCO's South American farm equipment sales, but with that program renewed for 2015, this should improve the outlook in a region responsible for 18% of sales.
While AGCO has no moat, during the last decade, the company has transformed itself from a barely profitable portfolio of farm equipment brands into a fairly profitable company with attractive global diversification and some countercyclical sales characteristics. Profitability should continue to improve over the long term. In mid-2015, it will begin to consolidate its small-tractor manufacturing, an initiative we expect to add 70 to 100 basis points to AGCO's 7% operating margin over the next several years.
Management shares our positive sentiment and purchased 7% of shares outstanding over the first nine months of 2014. Additionally, an AGCO affiliate and board member has purchased 3% of outstanding shares over the September through November time span and has expressed intentions to acquire more stock in the company.
TheStreet Ratings: Hold, C
TheStreet Ratings says:We rate AGCO CORP (AGCO) a HOLD. The primary factors that have impacted our rating are mixed -- some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its reasonable valuation levels and largely solid financial position with reasonable debt levels by most measures. However, as a counter to these strengths, we also find weaknesses including deteriorating net income, disappointing return on equity and poor profit margins.
You can view the full analysis from the report here: AGCO Ratings Report
2014 stock return: 29.8% (from Oct. 14, 2014)
Morningstar Rating: four stars (out of five), $15 fair value estimate
Morningstar says:We believe no-moat Fiat Chrysler has long been overly discounted and misunderstood by the market. However, we think this 4-star-rated stock is appropriate only for investors who are willing to accept the risks of a turnaround situation with a leveraged balance sheet in a cyclical, capital-intensive, highly competitive industry.
Our $15 fair value estimate includes the expectation that Italian demand will remain in a protracted recovery well into the second half of this decade; that Fiat retains its top market share in Brazil, albeit on an 18% slump in Fiat Latin American revenue for 2014; and estimated revenue and EBITDA that is roughly 20% below management's five-year plan.
At the beginning of 2014, the company purchased the remaining 41.5% stake in Chrysler that it did not already own. Fiat's ownership in Chrysler will enhance margin and returns as the two companies integrate common vehicle architectures and parts while making more efficient use of capacity, engineering, and corporate functions.
As of Oct. 13, the new entity incorporated in the Netherlands, and its corporate address is now in the U.K. Fiat Chrysler Automobile NV exchanged 1:1 new common for old shares of Fiat SpA. New shares are trading on the New York Stock Exchange under the ticker FCAU, with a secondary listing on the Milan exchange under the ticker FCA. The company has announced financing transactions that should take place during fourth-quarter 2014 and in 2015, including a secondary 100 million share offering of Fiat Chrysler treasury stock, up to $2.875 billion in mandatory convertible bonds, an IPO of 10% of Ferrari with Fiat's remaining 80% (10% held by Ferrari family) spun out to shareholders, and early payoff of Chrysler's credit facility and bonds.
TheStreet Ratings: No ratings available for this stock
General Motors Company (GM) designs, manufactures, and markets cars, crossovers, trucks, and automobile parts worldwide.
2014 stock return: -14.7%
Morningstar Rating: four stars (out of five), $53 fair value estimate
Morningstar says: GM is poised to see the upside to high operating leverage thanks to rising volume and smarter manufacturing than in the past, including a reduction in its vehicle platforms. We believe many investors are focused on the large pension/OPEB underfunding and the overhang of government and VEBA ownership. However, the pension will not be due all at once and is closed to new participants. Global pension underfunding at the end of 2013 fell by $7.9 billion, or 29%, compared with year-end 2012 because of a rise in interest rates. The U.S. Treasury exited GM in late 2013, and we expect the Canadian government to exit soon. GM also has a cash hoard that it could use for share buybacks or discretionary pension funding, and we like the announcement of a significant initial dividend in January 2014 of $0.30 a quarter, equivalent to about a 3.5% yield.
The GM Europe and GM International Operations segments will likely remain challenged in 2015, but Europe is improving rapidly while key holes in the U.S. product lineup (full-size sedan, full-size trucks, and SUVs) are now filled. We would not be shocked if Europe even made a profit in 2015 instead of 2016 as management has guided.
Old GM broke even with 25% U.S. share and a U.S. industry sales level of 15.5 million units, while new GM breaks even, depending on mix, at just 18%-19% share of 10.5 million to 11 million U.S. industry units.
The ignition switch recall increases headline risk and litigation risk, but we think GM can pay any fines or judgments that come its way thanks to $36.6 billion of automotive liquidity, including over $26 billion of cash.
In early June, we reduced our fair value estimate by $4 per share for a $7 billion reserve estimate for fines, lawsuits, and the compensation program related to the ignition switch recall. We think this accrual will likely prove too high, but we factor a conservative penalty into our valuation. GM said in July that the compensation program could cost it as much as $600 million, but many uncertainties on this fund and government fines remain.
TheStreet Ratings: Buy, B
TheStreet Ratings says: We rate GENERAL MOTORS CO (GM) a BUY. This is driven by several positive factors, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures and growth in earnings per share. We feel these strengths outweigh the fact that the company has had lackluster performance in the stock itself.
You can view the full analysis from the report here: GM Ratings Report
Airbus Group NV AIR.PA
2014 stock return: -26.4%
Morningstar Rating: four stars (out of five), 55 EUR
Morningstar says: Airbus commercial aircraft represents nearly two thirds of sales and has increased market share over the years. Airbus helicopters and defense and space comprise the other third of sales, and are likely to remain a smaller part of the group. CEO Tom Enders has loosened the vise grip of government control over decision-making and has focused the groups to generate a 7%-8% operating margin for 2015 (less 70 basis points to reflect A330neo launch costs).
Airbus competes in a duopoly with Boeing for commercial aircraft of more than 100 seats. Since the business was founded in 1970, its market share, in terms of annual deliveries worldwide, has increased from 15% to more than half the global market. The December 2010 launch and success of A320neo (new engine option), a fuel-efficient version of the popular A320, has given Airbus a dominant lead in single-aisle aircraft, where it maintains leading share of total orders. The massive EUR 765 billion commercial backlog provides nearly a decade of production visibility. Still, headwinds to profitability remain, with initial deliveries of the A350 to being in late December of 2014 and costly rework on the A380, the world's largest aircraft that launched in 2007.
Airbus helicopters' sales are about evenly split among the civil and military markets, as well as between platforms and services. Still, the competitive market, with players such as Bell and Sikorsky vying for share, has experienced softness in 2013 and 2014. And, Airbus is working through issues with its Super Puma that are hurting sales activity.
Defense and space includes the third-largest space systems company in the world, makes large transport military aircraft such as A400M, and makes the Typhoon fighter aircraft. Cost cutting measures started in 2012 and staff reductions are set to take hold from 2014 through 2017, which could deliver 10%-type margins for the segment.
Airbus faces some ongoing challenges, such as foreign exchange rate exposure, cost overruns, and the burdens of ongoing development programs that elevate R&D. Still, we believe Airbus can improve margins to high-single digits from low-single digits over the next couple of years.
TheStreet Ratings: No ratings available for this stock
Ford Motor Company develops, manufactures, distributes, and services vehicles, parts, and accessories worldwide. The company operates through two sectors, Automotive and Financial Services. The Automotive sector offers vehicles primarily under the Ford and Lincoln brand names.
Morningstar Rating: four stars (out of five), $23 fair value estimate
Morningstar says: Ford continues to increase its consideration in America, mostly because it did not take government loans and is making better cars. More emphasis on quality is paying off as well. In the U.S. last year, Ford gained the most share of any major automaker. Ford now makes cars people actually want to own instead of vehicles that are purchased only because of heavy incentives. Ford's challenge is to keep increasing share profitably while also elevating Lincoln into a global luxury brand. The mostly no-moat nature of the auto industry will make these tasks difficult.
Another key change is building more Ford models on common platforms, which will improve economies of scale. By 2016, Ford expects 99% of its global production to come from nine core platforms: five global and four regional. This move to nine platforms from 15 this year and 27 in 2007 will also allow Ford to switch production faster to meet changing demand while drastically cutting costs via better economies of scale than in recent decades. This change could save Ford billions of dollars in development costs. Management targets eight platforms as a long-term objective. The global subcompact and compact platforms (B and C segments) now each get more than 2 million units of annual volume. Before former CEO Alan Mulally's arrival, Ford had a different platform in each segment for each part of the world. The old way wasted billions and had volume too low to achieve the economies of scale Ford can achieve going forward.
The Ford and Lincoln brands are critical to the company's success. Fuel-efficient models, such as the Fiesta, Focus, and Fusion have been very well received. A strong luxury group will increase profits because it will allow Ford to sell to all consumer variants while retaining current Ford customers and selling Lincolns for more profit than Ford brand vehicles. For now, however, Lincoln's offerings put it more in the premium segment, so better product is needed, and this transformation will go beyond this decade. Lincoln's transformation will center on several new vehicles over time. Lincoln also entered China in fall 2014.
TheStreet Ratings: Buy, B
TheStreet Ratings says: We rate FORD MOTOR CO (F) a BUY. This is driven by a few notable strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its attractive valuation levels, good cash flow from operations, notable return on equity and increase in stock price during the past year. We feel these strengths outweigh the fact that the company has had sub par growth in net income.
You can view the full analysis from the report here: F Ratings Report
MSC Industrial Direct Co., Inc., together with its subsidiaries, markets and distributes various ranges of metalworking and maintenance, repair, and operations (MRO) products primarily in the United States.
Morningstar Rating: four stars (out of five), $95 fair value estimate
Morningstar says: MSC Industrial competes in the highly fragmented $5 trillion industrial distribution industry. The company largely competes in the maintenance, repair, and operations subsegment, where the top 50 distributors represent 30% of a $140 billion market. On the surface, the competitive dynamics suggest little ability to create a durable competitive advantage. However, distributors such as MSC Industrial perform a necessary function by aggregating demand on a national level, enabling customers to operate closer to optimal utilization levels and essentially eliminate inventory risk. Additionally, the company's suppliers prefer to sell via distributors because selling directly to end users often is prohibitively expensive and outside of manufacturers' core competency. In total, MSC performs the selling function for nearly 3,000 suppliers and sells to 325,000 customers. It provides value to each constituency and has generated an 18% average return on invested capital over the past 10 years.
Within the industrial distribution industry, MSC dominates the $10 billion metalworking segment and is roughly 5 times larger than its nearest competitor. MSC differentiates itself by competing on deep metalworking expertise, quick product delivery, and automated inventory stocking and ordering solutions for customers. MSC also differentiates its business from the competition through aggressive information technology investment, which has helped the company increase the ways it can service the customer, including vendor-managed inventory and vending management systems. These solutions make the purchasing process completely automated, so customers waste little time refilling orders. This emphasis on IT investment has raised website and electronic portal sales to 44% of the overall corporate sales.
TheStreet Ratings: Buy, B
TheStreet Ratings says: We rate MSC INDUSTRIAL DIRECT (MSM) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, reasonable valuation levels, growth in earnings per share and increase in net income. We feel these strengths outweigh the fact that the company shows weak operating cash flow.
- Written by Laurie Kulikowski in New York.