Hedge Funds’ Favorite Industrial Stocks: 2 To Buy, 2 To Avoid

By Ashish Sharma - June 27, 2012 | Tickers: CSX, GE, TYC, UNP | 0 Comments

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Each quarter, Bank of America analyst Mary Ann Bartels comes up with an analysis of 13F filings by the major hedge funds. Her report consists of the major buys and sells by the big funds and lists their top holdings in each sector. Here’s her list of the top ten industrial stocks that major hedge funds were holding at the end of last quarter:

I scanned the above list for good long candidates and Tyco International (NYSE: TYC) and General Electric (NYSE: GE) appear to be the most compelling.

Tyco International is seeing excellent business trends. Last quarter it posted organic revenue growth of 7.4%, which was its strongest in the last three years. To put this in context, some of its other multi-industry peers like Danaher and United Technologies posted just low single digit growth rates. In addition to strong revenue growth, the company's order inflow was also excellent at 13%, more than what it posted in the last few quarters.

Tyco is benefiting from the late cycle positioning of its Flow and Fire business, which is driving positive surprises. In addition to the cyclical nature of its businesses, Tyco also has one of the most defensible positions across the industrial sector, due to a large base of recurring revenues and services. Also, Tyco plans to split its business into three parts on September 30, 2012, which will lead to better capital structures and further upside.

General Electric is another interesting industrial stock. There are several potential catalysts for GE going forward. Near to medium term catalysts include execution around the coming gas power generation cycle, high & rising dividend yield, improving earnings quality, share repurchases and de-risking at GECC. GECC’s recent dividend announcement is a step in the right direction and gives increased confidence to GECC asset quality. Longer term catalysts include asset sales in GECC, sale of GE’s remaining NBCU stake, and eventually a more focused industrial portfolio. GE is currently trading at 11.25x forward PE and has a dividend yield of 3.50%. I believe the company offers an attractive risk-reward profile.

Two stocks in the above list which I will recommend avoiding are Union Pacific (NYSE: UNP) and CSX Corp. (NYSE: CSX). Railroads are usually early cycle stocks, which are first to see improvement when the broader economy recovers and first to see declines if the broader macros deteriorate. I don’t think it makes sense to build a position in them so late in the cycle. The downside risk if the macros deteriorate outweighs any upside potential at this stage. Hence it’s best to remain on the sidelines.

To sum up, Tyco’s late cycle positioning and proposed split make me positive on the stock. Low valuations of GE and several potential catalysts make it another interesting long candidate. However, it is best to avoid Union Pacific and CSX, given the early cyclical nature of their businesses.​

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