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The Ohio State University: SIM
Program
STOCK ANALYSIS- INDUSTRIALS SECTOR GARRETT GANDEE, SHI TING GU, STEVEN ROEHLIG
FIN 824 - Industrials Sector Overview
Overview of Industrials & Class Recommendation
Review of Current SIM Holdings Recommendations Conclusion
AGENDA
FIN 824 - Industrials Sector Overview
Sector Size Market Cap = 1.2 Trillion
Industries Air Freight & Logistics Airlines Building Products Commercial Printing Construction / Engineering Electrical Components Industrial Conglomerates Railroads Industrial & Construction Machinery Data Processing, Environmental Services Farm Machinery
INDUSTRIALS OVERVIEW
S&P Sectors
Industrials
FIN 824 - Industrials Sector Overview
CLASS RECOMMENDATION
FIN 824 - Industrials Sector Overview
2/7/2012 – Despite “Increase to Market Weight” recommendation by industrials team, class voted to maintain current underweight status.
CURRENT SIM HOLDINGS - INDUSTRIALS
FIN 824 - Industrials Sector Overview
• 2.23% of SIM Portfoloio • Unit Cost $77.76 • Current Price $83.78 (8%)
• 3.98% of SIM Portfolio • Unit Cost $97.17 • Current Price $118.56 (22%)
• 3.57% of SIM Portfolio • Unit Cost $50.53 • Current Price $52.43 (4%)
RECOMMENDATIONS
FIN 824 - Industrials Sector Overview
• 2.23% of SIM Portfoloio • Unit Cost $77.76 • Current Price $83.76 (8%) • Target Price $85.00 (1% Upside)
• 3.98% of SIM Portfolio • Unit Cost $97.17 • Current Price $118.56 (22%) • Target Price $111.14 (-6%)
• 3.57% of SIM Portfolio • Unit Cost $50.53 • Current Price $52.43 (2%) • Target Price $56.40 (7.6% Upside)
United Technologies Corporation provides technology products and services to the building systems and aerospace industries worldwide.
Business Consists of Six Segments: Otis segment designs, manufactures, sells, and installs passenger and freight
elevators, escalators, and moving walkways, as well as provides maintenance and repair services.
Carrier segment offers heating, ventilating, air conditioning, and refrigeration systems, controls, services, and energy-efficient products
UTC Fire and Security segment provides electronic security products comprising intruder alarms, and access control and video surveillance systems
Pratt and Whitney segment supplies aircraft engines for the commercial, military, business jet, and general aviation markets
Hamilton Sundstrand segment supplies aerospace products and industrial products Sikorsky segment manufactures military and commercial helicopters
FIN 824 - Industrials Sector Overview
UTX OVERVIEW
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL UTX
52 Week Range: $91.83 - $66.87 Current Price: $83.78 (2/17/2012) Our Target Price: $85.00 (1% Undervalued)
Standard & Poor’s “Fair Value Calculation”
Key Business Drivers Defense Spending, Aerospace, New Construction (Otis, Carrier) Review of ROE for UTX
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL UTX
1 Year 3 Years 5 Years 9 Years
ROE 24.84 22.41 22.85 22.42
UTX
Analyst: Shi Ting Gu
Terminal Discount
Rate = 10.5%
Date: 01/23/12
Terminal FCF
Growth = 3.0%
Year 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E
Revenue 58,432 62,090 71,025 73,866 76,082 78,365 80,716 83,137 85,631 88,200 90,846 % Growth 6.3% 14.4% 4.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Operating Income 7,685 8,469 9,772 10,329 10,639 10,959 11,287 11,626 11,975 12,334 12,704 Operating Margin 13.2% 13.6% 13.8% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0%
Interest and Other 526 745 845 591 609 627 646 665 685 706 727 Interest % of Sales 0.9% 1.2% 1.2% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8%
Taxes 1,933 2,240 2,392 2,610 2,688 2,769 2,852 2,938 3,026 3,116 3,210 Tax Rate 27.0% 29.0% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8%
Net Income 4,926 5,146 6,215 7,069 7,282 7,503 7,730 7,963 8,204 8,452 8,707 % Growth 4.5% 20.8% 13.7% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Add Depreciation/Amort 1,300 1,400 1,500 1,699 1,750 1,802 1,856 1,912 1,970 2,029 2,089 % of Sales 2.2% 2.3% 2.1% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% Plus/(minus) Changes WC (1,078) (600) (1,965) (1,256) (1,293) (1,332) (1,372) (1,413) (1,456) (1,499) (1,544) % of Sales -1.8% -1.0% -2.8% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7% Subtract Cap Ex 900 950 1,000 1,108 1,141 1,175 1,211 1,247 1,284 1,323 1,363 Capex % of sales 1.5% 1.5% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%
Free Cash Flow 4,248 4,995 4,749 6,404 6,598 6,797 7,003 7,215 7,433 7,658 7,890 % Growth 17.6% -4.9% 34.8% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
NPV of Cash Flows 38,511 49%
NPV of terminal value 39,922 51% Terminal
Value 108,352 Projected Equity Value 78,433 100%
Free Cash Flow Yield 5.50% Free Cash
Yield 7.28%
Current P/E 15.7 15.0 12.4 Terminal
P/E 12.4 Projected P/E 15.9 15.2 12.6
Current EV/EBITDA 12.2 11.1 9.7
Terminal EV/
EBITDA 9.5 Projected EV/EBITDA 12.3 11.2 9.8
Shares Outstanding 923
Current Price $ 83.78 Implied equity value/share $ 85.00 Upside/(Downside) to DCF 1.5%
Debt 38,033 Cash 5,966 Cash/share 6.47
FIN 824 - Industrials Sector Overview
FIN 824 - Industrials Sector Overview
STOCK VALUATION
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL UTX
Our Target: $85.00
Company’s performance greatly affected by foreign market. Sales for 2011 from outside the United States were 61% of its total segment sales.
Potential reduction in military demand: U.S. pulled out army force from Iraq in 2011, and President Barack Obama is signaling he wants to get out of Afghanistan.
FIN 824 - Industrials Sector Overview
DEFENSE BUDGET CUTS
In September 2011, UTX acquired Goodrich Corp for $18.4 billion which is a global supplier of systems and services to the aerospace and defense industry.
Economist criticized that UTX was paying too much to buy GR when the market is in a far worse shape.
This acquisition will not be accretive to profit at least until fiscal 2013. But expected revenue 2012 will still be in the range of estimated revenue 2012.
FIN 824 - Industrials Sector Overview
ADDITIONAL UTX CONCERNS
Global manufacturer of industrial pumps and related equipment for the chemical, oil, gas, and power industries
Market Cap: $6.587 Billion Sub-Industry: Industrial Machinery
FIN 824 - Industrials Sector Overview
FLOWSERVE OVERVIEW
52 Week Range: $135.72 - $66.84 Current Price: $118.56 Our Target Price: $111.14 (6% Overvalued)
Standard & Poor’s “Fair Value Calculation”
Key Business Drivers Capital Expenditures in Oil & Gas, Chemicals, and General Industrials
Review of ROE for FLS
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL 50% FLS
1 Year 3 Years 5 Years 9 Years
ROE 19.94 26.75 22.90 15.50
FIN 824 - Industrials Sector Overview
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL 50% FLS
• Price ratio valuation
FIN 824 - Industrials Sector Overview
JUSTIFICATION – SELL 50% FLS
Our Target: $111.14
Time to take profits off the table. FLS has returned 22% over its unit cost of $97.17.
FLS is currently 6% over our target price of $111.14 However, our model differs greatly from analysts’ consensus estimates
(target of $135 - $145). Flowserve is highly correlated with the price of oil. ( ) Increased capital expenditures on oil and gas in the US (shale
plays), and in emerging markets will benefit FLS. ( ) Let’s keep 50% of our FLS shares in the game.
FIN 824 - Industrials Sector Overview
JUSTIFICATION- SELL 50% FLS
Designs, manufactures and markets professional, medical, industrial and commercial products and services.
Operates in five business segments: Test & Measurement Environmental Life Sciences & Diagnostics Dental Industrial Technologies
Growth is derived from segment core expansion and frequent external acquisitions.
FIN 824 - Industrials Sector Overview
DANAHER OVERVIEW
Positives: Increasing sales in foreign markets, notably those
with growing economies. Strong sales and margin growth, including digit
core margin growth in Industrial Technologies and Test & Measurement segments. Margins now above 20% in both segments.
Gross margin has been higher than its industry average for each of the past five years.
The company has targeted acquisitions of companies with gross margins above 50%.
FIN 824 - Industrials Sector Overview
DANAHER OVERVIEW
52 Week Range: $56.09 - $39.34 Current Price: $52.43 Our Target Price: $56.40 (7.6% Undervalued)
Standard & Poor’s “Fair Value Calculation”
Key Business Drivers Segment core expansion and frequent external acquisitions
Review of ROE for DHR
FIN 824 - Industrials Sector Overview
JUSTIFICATION – HOLD DHR
1 Year 3 Years 5 Years 9 Years
ROE 12.64 12.51 13.38 15.42
FIN 824 - Industrials Sector Overview
DANAHER VS. S&P 500
FIN 824 - Industrials Sector Overview
FIN 824 - Industrials Sector Overview
JUSTIFICATION- HOLD DHR
• Price ratio valuation
FIN 824 - Industrials Sector Overview
JUSTIFICATION- HOLD DHR
Our Target: $56.41
FIN 824 - Industrials Sector Overview
JUSTIFICATION- HOLD DHR
• On 1/31/12, the company announced quarterly earnings of 0.81 per share, a positive surprise of 3.5% above the consensus 0.78.
• Over the past 4 quarters, the company has reported 4 positive, 0 negative, and 0 in-line surprises.
Over 70% of sales growth in the last 5 years has come from acquisitions.
Increasing sales in foreign markets may slow down with rising concern in foreign markets.
FIN 824 - Industrials Sector Overview
DANAHER CONCERNS
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
Industry
Diversified Machinery
Aerospace and Defense Products and Services
Industrial Electrical Equipment
Farm & Construc@on Machinery
Industrial Equipment & Components
Waste Management
General Building Materials
Metal Fabrica@on
Aerospace & Defense – Major Diversified
Heavy Construc@on
Residen@al Construc@on
Machine Tools & Accessories
Small Tools & Accessories
Cement
General Contractors
Tex@le Industrial
Pollu@on & Treatment Controls
Lumber, Wood Produc@on
Manufactured Housing
A large number of the industries we assigned a positive outlook to will greatly benefit from an upturn in new construction
Construction Sub-Industries
BUILDING MATERIALS FARM & CONSTRUCTION
MACHINERY RESIDENTIAL CONSTRUCTION CEMENT GENERAL CONTRACTORS LUMBER/WOOD PRODUCTION MANUFACTURED HOUSING
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
Of those sub-industries, our recommendation would be to target Construction & Farm Machinery & Heavy Trucks. Improving global economy since 2010 Global nonresidential construction markets are
improving Domestic housing market bottoming Robust construction growth in emerging nations Aging equipment in mature economies Farm income (primary driver for agricultural
equipment sales, rose by 28% in 2011. FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
Caterpillar, Inc. is the world’s largest producer of earthmoving equipment, and a big maker of electric power generators and engines used in petroleum markets, and mining equipment
Caterpillar construction machines are in service in nearly every country in the world. 65% of sales derived outside North America.
Current Price: $113.95 52-Week Range: $116.55 - $67.64 Market Capitalization: $72.26 Billion
Our Target: $136.78 (20% Upside)
S&P “Fair Value Calculation”
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
FIN 824 - Industrials Sector Overview
NEW STOCK RECOMMENDATION
Our Target: $136.78
FIN 824 - Industrials Sector Overview
FIN 824 - Industrials Sector Overview
JUSTIFICATION – BUY CAT
• Price ratio valuation
Class Voted to Keep Industrials Sector Underweight, and stay at 9.78% of total SIM portfolio.
SELL 223 bps of UTX (100% of UTX in SIM Portfolio) SELL 200 bps of FLS (50% of FLS in SIM Portfolio) BUY 423 bps of CAT
HOLD 198 bps of FLS HOLD 357 bps of DHR
FIN 824 - Industrials Sector Overview
SIM INDUSTRIALS PORTFOLIO CHANGES
10%
90%
SIM Industrials Weight
Industrials
Rest of Portfolio
Old Holdings
23%
41%
36%
SIM Industrials
UTX FLS DHR
New Holdings
43%
20%
37%
SIM Industrials
CAT FLS DHR
FIN 824 - Industrials Sector Overview
SIM INDUSTRIALS PORTFOLIO CHANGES
FIN 824 - Industrials Sector Overview
RECOMMENDATIONS SUMMARY- INDUSTRIALS
SELL 223 bps (ALL) of
SELL 200 bps (HALF) of
BUY 423 bps of
HOLD Current Position of
HOLD 198 BPS of