2 2009 Fall FOCUS Investment Conference Industrials Aggressive cost actions have led to better than expected trough margins in the sector. The recovery will be supported by emerging market growth and global stimulus. However, positive earnings leverage may be muted compared to prior cycles, due to the reversal of the price-commodity tailwind and the return of temporary expenses. The overall outlook for the global industrial sector has improved significantly over the last few months.
3 2009 Fall FOCUS Investment Conference S&P Industrials vs. S&P 500 Performance – 1 yr Source: FactSet
4 2009 Fall FOCUS Investment Conference S&P Industrials vs. S&P 500 Performance – 5 yr Source: FactSet
5 2009 Fall FOCUS Investment Conference Conglomerates, Electrical Equipment, and Machinery Source: FactSet
6 2009 Fall FOCUS Investment Conference Over the last several months, major economic indicators have stabilized and inventory destocking has slowed. Europe continues to lag the US and the rest of the world. Investors expect global capital expenditures to remain muted compared to prior cycles because of excess capacity. However, growth should be supported by emerging markets and global stimulus. Based on 2010 earnings estimates, the Industrial Conglomerates sector (~19x), Electrical Equipment sector (~22x), and Machinery sector (~23x) are trading at a cyclical premium to the S&P 500. We prefer companies that will gain share in their end markets, take advantage of secular trends, and continue to reduce costs. Our top picks are DHR and ABB. Conglomerates, Electrical Equipment, and Machinery These stocks have outperformed over the last three months, due to bottoming fundamentals and an improving global economic outlook.
7 2009 Fall FOCUS Investment Conference Aerospace/Defense Source: FactSet
8 2009 Fall FOCUS Investment Conference Aero industry fundamentals are stabilizing and will continue to improve in 2H09 due to easier comps. The new 787 schedule (August 2009) was better than consensus, but there still may be delays in the retrofitting and certification process. Aero stocks are trading at ~15x 2010 earnings and ~13x 2011 earnings. Further upside would be driven by continued improvement in fundamentals such as RPKs, ASKs, and airline profitability. We are positive on companies that are levered to the 787 production ramp and the commercial aftermarket. Our top picks are COL and BA. Aerospace These stocks have outperformed recently, as declines in key indicators have moderated and expectations for 787 have recovered.
9 2009 Fall FOCUS Investment Conference The DoD has requested $534B in base funding for FY10, +4% yoy, and $130B in overseas contingency operations (supplemental) funding. Longer term, we expect the defense budget to decline, as the Obama Administration will reign in excessive spending and scale back costly programs. We expect defense shares to underperform, due to the declining budget environment and the rotation into higher beta names. Defense shares are trading at ~10x 2010 EPS and ~9x 2011 EPS, which is typical at this point in the cycle. We are recommending LMT due to the companys key positions on the F-35 and other strategic programs. Defense Defense stocks have lagged the S&P and Industrials in 2009, as investors have rotated into economically-sensitive stocks.