Buying Opportunity or Value Trap?

■

What’s priced in? Given the 14% decline in the XLI since its peak on 5/19, we

thought it would be helpful to re-visit our recession-probability analysis to provide

better perspective on what’s priced into capital goods stocks at these levels. It’s

clear the odds of a recession have dramatically increased across sub-sectors as

global growth expectations have become notably more muted. Valuations in the

cap goods space appear increasingly attractive but sentiment continues to sour,

making stock selectivity critical. This report aims to quantify which stocks have

the least downside risk / most upside potential from current levels. Our analysis

indicates that CBE, UTX, HON, SPR, NOC and DE are pricing in the highest

probabilities of a recession and present the least downside risk for

investors.

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More headwinds and fewer tailwinds in 2009... We’ve become increasingly

bearish over the past months and recent datapoints have only confirmed

investors’ worst fears. Business activity markedly slowed in May and June as

evidenced by ROK and OSK’s negative preannouncements last week. Western

Europe is decelerating at a rapid clip and we believe there is increasing risk to

the emerging market story as centrals banks hike rates to combat inflationary

pressures stemming from a prolonged food and fuel shock. Oil surpassing

$130/barrel has been felt across sectors but especially in Aerospace where

capacity reductions could serve as a precursor to reduced aftermarket demand,

potential backlog erosion and airline bankruptcies. As we’ve previously noted,

rising material costs will likely pressure profitability for all the companies in our

space as we move through ’08 and into ’09 and we believe margins could be

approaching peak levels. Combine this with continued tightening of credit

standards and deteriorating portfolio quality at captive finance businesses and

it’s no wonder investors are staying on the sidelines.

■

…leave investors wondering where to hide within the industrials space.

The most common incoming call we receive these days is what to own within the

industrial space. While stocks may appear cheap, we’d caution that valuations

can be deceiving given negative sentiment, eroding fundamental outlook and

rising oil prices. We wouldn’t be surprised to see industrial stocks trade

inversely to oil prices regardless of valuation given the magnitude of the

implications from rising crude. That said, Energy, Defense and Agriculture

remain the best themes to play in the industrials space, supported by solid

secular stories. Within EE/MI, stocks levered to Power, T&D and Oil & Gas

should continue to work as investors rotate into the names despite premium

valuations. Within A&D, Defense stocks are likely to outperform as baseline

funding rises modestly through the next administration. On the Machinery side,

AG is 100% tied to agricultural fundamentals and should perform better than

peers in an economic slowdown.

[此贴子已经被squarekiss于2008-7-28 9:31:06编辑过]