Industrials Are the Good Play Now: Morgan Stanley

There are attractive valuations in industrial stocks, Morgan Stanley said in a note to clients.

"We remain overweight industrials as a sector with some valuation support and near-term earnings strength," the bank wrote.

Atop the list of attractively priced industrials is Alcoa Corp.  (AA) , which has been hurt this year in the face of Donald Trump's tariffs binge, which slapped big taxes on imported aluminum. Alcoa makes a lot of aluminum in Canada, one of the countries to get hit with the tariffs, and sells in the U.S.

"One new and recurring unfavorable impact is tariffs on our imports into the U.S. mostly from our Canadian smelters," William Oplinger, Alcoa CEO, said on the company's  earnings call in July. The stock is down more than 24% this year.

Morgan Stanley thinks the stock is oversold, giving it a $57 price target, roughly 26% above its current level. "After a post-2Q18 sell off, we see compelling valuation and a constructive 4Q18 setup," the bank said in its note. A fat dividend might also sweeten the deal. "We think Alcoa will start paying a dividend (50% of FCF) within ~3 months, some operational headwinds from 2Q will abate." 

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Ford Motor Co.  (F) is a good pick too, according to Morgan Stanley. Shares of the carmaker have fallen 26% this year, and Morgan Stanley said "Ford represents a cheap call option on restructuring, trucks, data, and some-of-the-parts potential."

Ford received a credit downgrade from Moody's in August. The Moody's note said "continued losses are likely to worsen because of Brexit related costs from Ford's U.K. operation." Morgan Stanley analyst Adam Jonas, on the same day, warned of the company's cash flow, saying, "We believe investors should anticipate Ford cash flow to fall substantially short of its dividend payment next year." Still, his price target is $15, roughly 37% above where the stock is now.

"Ford's out-of-favor status has brought valuation to where the F-150 may be worth close to 200% of end value," said Morgan Stanley's note on Wednesday.

Honeywell International Inc.'s   (HON) reorganization could create attractive value as well. "Honeywell represents a long-term rerating opportunity as the company spins out slower growth assets and emphasizes tech differentiation, creating a 2x GDP growth algorithm in a sector where growth is increasingly scarce," Morgan Stanley said. Its price target is $175, roughly 7% above the stock's current level. 

Of course, the threat of more tariffs could cause future pain to many industial stocks,  and that threat, as of right now, hasn't gone away completely. Expansion of tariffs would add fuel to the fire," John Toohey, USAA's head of equities, recently told TheStreet. "Costs are rising for U.S. companies," he added, which is partly a result of tariffs Trump has slapped on major trading partners to the U.S., like China and the EU

But for right now? Industrials are the play, Morgan Stanley advised. 

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