Big Upside Potential for This High Quality Industrial Company

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Due to uninspiring growth on a global scale, the current economic context doesn´t look particularly bullish for companies in the industrial sector. This is precisely the reason why contrarian investors may want to consider capitalizing the opportunity to buy solid industrial stocks at bargain prices with a long term perspective. The Timken Company (NYSE: TKR) stands out like a high quality candidate with a very attractive valuation.

Making Smart Decisions

The company supplies anti-friction and power transmission components to an ample variety of industrial clients. Its products are used to reduce frictions in planes, trains and automobiles. Timken is also in the steel business, manufacturing specialty alloy steel bars, tubes and precision components. Although the company is quite diversified, it’s very exposed to the economic cycle, which is the main reason for disappointing sales and earnings in the last quarter.

Timken has been restructuring its business over the last years in order to focus on segments with better possibilities for differentiation and higher profitability. In 2009 the company sold its needle roller bearings business to JTEKT for $330 million to reduce its presence in the light vehicle market, and Timken has also made several acquisitions in the aerospace and industrial sectors since 2007. This restructuring has delivered positive results, as the company has been able to achieve better profitability margins because of this focus in more attractive markets.

Regarding steel operations, Timken follows a similar differentiation strategy by focusing on specialized steels utilized in demanding environments like oil and gas exploration and production. This allows for higher margins in comparison to commodity steels, and Timken uses surcharges to adjust for higher input costs. Growth perspectives for this business look attractive too, Timken is working on an expansion project in its Faircrest steel plant which is expected to add 25% in capacity by 2014.

Quality and Valuation

When comparing Timken to similar companies like Illinois Tool Works (NYSE: ITW), Kennametal (NYSE: KMT), Nucor (NYSE: NUE) and United States Steel (NYSE: X), the company has delivered a superior performance through the ups and downs of the last economic cycle. Timken has experienced better growth rates in earnings per share over the last five years, including of course the seriously damaging effects of the 2008-2008 recessions.

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While many industrial companies needed to cut their dividends in times of economic trouble, Timken has sustained a dividend payment since 1922, and those payments were even increased by a 15% in February of this year. Timken also has authorization from the board to repurchase 10 million of its own shares over the next four years.

Timken has not only achieved higher growth rates than its competitors, the company has superior profitability as expressed by its higher Return on Equity ratio. And, especially important, it’s trading at a comparatively cheap P/E ratio of 7.6 which leaves ample room for upside gains form a valuation pint of view.

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Bottom Line

There are genuine reasons for concern regarding the cyclical outlook for industrial companies, but those uncertainties are already reflected in stock prices. Timken´s management has made the right decision to focus on high quality niches in its different business lines, and that´s produced superior growth and profitability for the company. In spite of that, current valuation is signaling strong upside potential in this high quality company.

acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Kennametal and Nucor. Motley Fool newsletter services recommend Illinois Tool Works, Kennametal, and Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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