Weak Economy but Strong Industrials...How?

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

My followers might remember that I extensively covered industrial stocks before the start of the earnings cycle. Most of them have realized their gains. However, I still believe that three of those will still experience a rally and the good news has not been properly factored in these stocks:

General Electric (NYSE: GE)

One of the Dogs of the Dow, holding this stock has been considered as riskless as a Treasury bond. Many people hold it to get an annual return of 3.5% (which is in fact, its dividend yield). In a downside macro environment, the 75%+ of GE’s Industrial earnings that are aftermarket-related should hold up well. If the recovery continues, GE has high exposure to growth themes such as US / China gas power generation, and a long-cycle aero engines build-out. Overall, the company’s industrial segments are performing exceptionally well, leading to a rise in margins as well as revenues.

Capital allocation should improve materially given GECC dividend. Time and again, bears have chanted criticism against this stock especially calling GECC as a big drag on the company’s profitability. No doubt GECC has been a source of trouble for the company, but the management continues to highlight the strategic “core,” which includes middle market lending, GECAS and EFS, which has sent bullish signals to the market. The M&A environment may not be conducive to a large exit in the near term. I think the company will look to be opportunistic here, perhaps over the next 12-18 months. The regulatory environment remains stable with no surprises to date under Fed supervision and with the company having fully prepared to be a Systemically Important Financial Institutes (SIFI).

ADT Corporation (NYSE: ADT)

A $2 billion buyback ahead (~$1 billion before September 2013), a rich pipeline of accretive M&A possibilities, cheap cost of capital, highly visible mid-to-high single digit organic growth (with limited sensitivity to macro conditions), a motivated management team and undemanding valuation gives me a high conviction in the buy recommendation. The M&A activity, clarity on metrics that drive value in the business model, and execution are key incremental catalysts for 2013.

It is important to note that the company recently announced its earnings release for 4Q. The stock hardly moved despite an earnings beat. Also, I was surprised that an announcement from the company to accelerate its buyback activity hardly moved the stock. This makes me believe that the stock will move in case a catalyst hits the stock.

Gardner Denver (NYSE: GDI)

The buy side consensus seems to be too negative on Gardner Denver. Last month, Jim Cramer said that the company doesn’t have good fundamentals. However, the sell-side thinks the stock could outperform given:

(1) The catalyst of European cost cutting announcement, boosting margins;

(2) The capital allocation improving (buyback likely to be extended);

(3) A possible corporate action (ValueAct are pushing for a sale; peers like Robbins & Myers are being acquired).

On Feb. 11, MKM partners upgraded the stock and stated the following:

“We believe an improving macro environment, a positive 4Q preannouncement and signs of stabilization in pressure pumping should point to upside in valuation. In light of improving fundamentals and the recent strength in the shares of GDI’s peers, the Board may look for more than the $75-$80 per share offer that has been widely reported in the media.”

Therefore, Feb. 15 will be an important date for GDI’s investors.

Foolish Bottom Line

It is interesting to note that despite a sluggish macro environment, some industrial stocks have shown a remarkable rate of capital appreciation, and some are still set to grow due to stock-specific reasons. 

AnalystX has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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