1. Jie Jin, Tyler Keister, Austin Kotler, Brian Kountz
Industrials Sector
Jie Jin, Tyler Keister, Austin Kotler, Brian Kountz
Spring 2017

2. Overview Business Analysis Economic Analysis Financial Analysis
Agenda
Overview
Business Analysis
Economic Analysis
Financial Analysis
Valuation Analysis
Recommendation

3. S& P 500 Sector Breakdown

4. SIM Sector Breakdown
SIM holdings are 14 basis points above S&P 500

5. Sector Performance

6. Subsector Performance
A&D:
+ : Growth from strong government spending both at home and abroad (India)
- : Potential Trump tariff on aluminum and steel
Industrial Conglomerates:
+ : Strengthening global economy offers opportunities in multiple lines of business
- : Strong incentives for breaking up (GE & UTC)
Air Freight & Logistics:
+ : Consumers want goods faster than ever before
- : Changing nature of logistics methods and strong competition

7. Company Breakdown Current Order SP 2017 Market Cap ($B) Boeing Co 3
202.61
3M Co 2
137.52
General Electric Co 1
126.16
Honeywell Intl Inc 4
111.60
Union Pacific Corp 7
99.44
United Technologies Corp 6
104.30
Caterpillar Inc 10
89.73
Lockheed Martin 8
96.77
United Parcel Service Inc B 5
90.70
Raytheon Co -
61.46

8. Threat of Substitution
Business Analysis
Threat of New Entry
Capital-Intensive with high fixed costs
Require relative technology and patents
Government restrictions and legislation
LOW
Competitive Rivalry
Threat of New Entry
Buyer Power
Threat of Substitution
Supplier Power
Power of Customers
Price sensitive
Consistent number of buyers
Switching costs depend on sector
MODERATE
Threat of Substitution
Directly competing peers
Switching costs depend on subsector
MODERATE
Power of Suppliers
Lots of suppliers
Difficult to differentiate
Low switching costs
Commodity-based services means pricing power is limited
LOW
Competitive Rivalry
Many players about same size, no dominant firms
Little differentiation
Mature industry with little growth, must steal from competitors
HIGH

9. Business Analysis
Inflation is heating up, but still low at 2.1% (January) vs. Fed target of 2.5%
Fed funds rate is historically low at 1.5%.
Productivity remains stubbornly low.
Unemployment is very low at 4.1%
With this we predict this Business Cycle to last a minimum of 2 years and a maximum 5 years.
This is GOOD news for Industrials
Going from business analysis to economic analysis, we first looked at the macro level because where we are at in the business cycle has a lot of effect on the industrials sector. So, although inflation is heating up, we are still in a low inflation environment at 2.1% as opposed to the Fed target of 2.5%. In addition, the  fed funds rate has just begun to be raised in 2015, but is also historically low at 1.5%. Also, as our STRS economic guest pointed out, productivity is stubbornly low indicating that we have additional room for expansion. Plus unemployment is very low at 4.1%. And finally consumer/business sentiment is very high; we believe that we are just entering the expansion phase of the cycle. Given this information, we believe that we still have at least 2 years and as much as 5 years before a major market correction. All of these macro indicators point to Industrials being able to outperform the S&P 500.

10. Industrials vs S&P 500 Correlation = 0.927 Correlation = -.437
This is a regression of the industrials index vs. the S&P 500 since 1988, as you can see R, or the coefficient of correlation, is a high positive This data shows wherever the S&P goes industrials are likely headed in the same direction.

11. Industrials vs US Unemployment
Correlation = -.437
Correlation = -.437
Correlation = .212
As you can see, this regression shows a strong negative correlation between unemployment and industrials; however at our low rate of 4.1%, one has to wonder how much wider this spread could get.

12. Industrials vs Industrial Metals
Correlation = .376
Industrial metals gets a little more interesting in the wake of the possible tariffs on steel and aluminum; however with a positive correlation of .376, industrials may actually end up benefiting from this change in trade (even though I’m firmly against it)..

13. Industrials vs Energy Commodities Index
Correlation = .170
This regression between industrials and energy commodities shows a very low positive relationship at .17, and looking back further than 2007 one has to account for the Enron energy scandal that breaks in late ‘01 and early ‘02. Because of these inflated energy prices it becomes very difficult to draw a conclusion from this data.

14. Industrials vs Oil (since 1988)
Correlation = -.103
Due to the positive correlation between the construction equipment industry and the negative correlation between airline component of the industrials sector, oil is very interesting for industrials. However, if we max out our date scope back to 1988 we see there is a negative correlation of and the industrials sector.

15. Industrials vs Oil (since 1988)
Correlation = -.103
However, if we limit our inquiry to 2007 to present, we see that oil and industrials actually have a positive correlation of .301, which would have been even higher had OPEC not cut production and  jacked up the prices so high in However, with oil prices staying so low (as you can see by the gold line on the bottom) we expect this giant spread between industrials and oil to shrink in the coming years. While we hope US shale continues to keep prices down, we don’t expect that to persist much longer.

16. Economic Analysis
President Trump’s Tax Cuts will continue to boost investment from Corporations.

17. Financial Analysis
Here we have the income statement on the top right diagonal corner and the balance sheet on the bottom left. Across all categories we see modest gradual growth, with a few minor slip ups, but nonetheless we have growth.

18. Financial Analysis
Here we have the income statement on the top right diagonal corner and the balance sheet on the bottom left. Across all categories we see modest gradual growth, with a few minor slip ups, but nonetheless we have growth.

19. Financial Analysis
As we can see from the graphs here, Turnover has been relatively stable, operating and profit margins are decreasing, and return on equity has been rising (which is also a sign that the index is getting expensive). You can also see that analysts are growing pessimistic on the index level. If one goes further back in time they would also note that operating and profit margins have gradually decreased over time and that trend continues through the projections.

20. 3 Year Return White = S&P 500 Yellow = Snap-On Green = Eaton
Pink = United Airlines
Red = Worldpay

21. 10 Year Return White = S&P 500 Yellow = Snap-On Green = Eaton
Pink = United Airlines
Red = Worldpay

22. SIM Year to Date White = S&P 500 Yellow = Snap-On Green = Eaton
Pink = United Airlines
Red = Worldpay
This graph shows the year-to-date performance for SIM relative to the industrials index of the S&P.

23. Valuation Industrials vs S&P 500
P/E
P/Bk
P/S
P/CF
On a P/E basis for both Ind and SP500 trading at 21x, both are richly valued historically. Have had expansion in recent years because of corporate earnings growth
Technical analysis shows an upward trend over last decade by all metrics and Ind and market have very consistent periods of volatility in line with each other.
Charts suggest both the market and industrials sector may be approaching their resistance lines, especially given the context of this 9-year bull market with equity indices starting to come down from record highs, we think valuations will contract for both the market and industrials given their historical valuations and long-term reversion to the mean
Moving forward, in the short-term however, lower corporate tax rate tends to support investment spending, from which Industrials stand to gain relative to the market

24. Industry to Industry Valuations
Consistent valuations and trends EXCEPT:
Q Q Building Products Industry (Orange)
Q Q Airlines (Red)

25. Recommendation OVERWEIGHT Subsectors OVERWEIGHT
Aerospace & Defense
Construction Equipment
Road & Rail
UNDERWEIGHT Subsectors
Airlines
Air Freight & Logistics
OVERWEIGHT
Early enough in economic cycle to thrive
Rising oil prices can actually help industrials, but hurt airlines
Trump’s tax cuts will help investment With industrials’ ability to benefit from rising metal prices, tariffs may actually help
Industrials appear to be expensive as a whole, but there are opportunities within the sector