The overall news regarding the US economy has been good, there’s no doubt about that. Annualized growth was 2.3% in 2019, which was nothing to write home about but still indicative of expansion. The January 2020 jobs report showed an expanding labor market as more job hunters looked for work, along with upwards revisions to the December and November numbers.
However, buried in all of the data, there were some warning signs related to manufacturing. PMI, the purchasing managers index, used as an indicator for future manufacturing growth, was down for the third month in a row, although the 51.9 reading beat the 51.7 expectation. It also doesn’t help that industrial output is down year-over-year.
President Trump’s ‘trade war’ policy towards China gets much of the blame for the downward trend in industry. The US and Chinese economies, the world’s first and second largest, are interconnected in a complex web of imports, exports, and reimports, as companies manufacture parts, ship them, put them together into final products, and export those for sale. The Phase 1 agreement between the two governments, promising relief from trade dispute and tariff pressures, gave hope for an industrial and manufacturing recovery. The coronavirus outbreak in China, however, with its quarantines and travel disruptions, is threatening to set back this major sector.
Goldman Sachs analyst Jerry Revich, in a major report on industrial stocks, sees potential for a general sector turnaround. He argues leading indicators for US machinery production are rising, along with increases in construction equipment inventories. Making use of the TipRanks database and Stock Comparison tool, we have taken a closer look at three of Revich’s more interesting industrial stock picks.
Caterpillar, Inc. (CAT)
Caterpillar, long a staple of the Dow Jones index, is known worldwide by its famous yellow logo, and the name ‘Cat’ is instantly recognizable in construction industry. The company manufactures heavy excavation and construction equipment, from bulldozers to excavators and everything in between, and its vehicles are found around the world. The general slowdown in 2H18 was hard on the company, and CAT stock had difficulty regaining traction through most of a volatile 2019. But in Q4, the shares began to gain again.
The company reported mixed results in Q4. EPS was $2.63 for the fourth quarter, beating the forecast by 11%, and more importantly, gaining 3% year-over-year. This compares especially well to the Q3 results, which missed expectations by almost 6%. The gains in earnings came even as revenue missed the estimates.
Furthermore, CAT has a long history – over 15 years – of maintaining and growing its dividend payment. The current payment, $1.03 per quarter, annualizes to $4.12 and gives a yield of 2.99%. For context, dividend yields average about 2% on the S&P 500, so CAT’s is 50% higher – and it is almost double the yield of US Treasury bonds. With a payout ratio of only 39%, this dividend is secure for the foreseeable future.
Back in August, Goldman Sachs' Revich set a Hold on CAT stock. He has since changed his tune, and upgraded this stock from Neutral to Buy. Revich, says, backing his new rating, “We see a combination of (i) tightening US construction equipment capacity utilization, (ii) dealer inventories and backlog approaching trough levels, and (iii) margin tailwinds in 2021 from reduced restructuring and inventory destock.”
In line with his Buy rating, Revich put a $168 price target on CAT, implying a 12-month upside of 23%. (To watch Revich’s track record, click here)
Like many industrial stocks, CAT has mixed reviews from Wall Street’s analysts. With 6 Buys, 5 Holds, and 1 Sell, CAT shares get a Moderate Buy from the analyst consensus. The stock is currently trading for $137, and the $155.09 average price target suggests room for 13.55% upside growth. (See Caterpillar stock analysis on TipRanks)
Cummins, Inc. (CMI)
While not a household name, Cummins is a major supplier in heavy industry. The company specializes in engines and ancillary components for heavy vehicles. Its products are split into several categories, including – among others – engines, power systems, filtrations systems (for engine components), and emission solutions.
Cummins’ earnings declined through 2019, but Q4 showed an important gain – it beat the both earnings and revenues estimate by wide margins. Top line revenues came in at $5.58 billion, 4.5% over the forecast. While down year-over-year, the revenues supported EPS of $2.56, 5.8% better than expected. In the days since the Q4 release, CMI shares have gained 3.5%.
Like CAT above, CMI slipped in 2H18, and was volatile in 2019. The stock is up 12.5% in the last 12 months, however, in a general indication of investor confidence. That confidence is smoothed along by the CMI dividend, which is even stronger than CAT’s. CMI pays out $5.24 annually, or $1.31 per quarter; the 51% payout ratio indicates a sustainable commitment to sharing profits with stakeholders. The yield, at 3.14%, is double that of Treasury bonds and well above the average in the broader markets. CMI has raised the payment 3 times in the last three years.
This stock is Revich’s second major industrial upgrade. He has bumped the rating up from Neutral to Buy, and set a $200 price target, suggesting a robust upside of 20%.
Defending his decision to upgrade Cummins, Revich points out favorable trends in the trucking industry, which in his view outweigh risks from exposure to Asian markets: “We believe i) US truck leading indicators have inflected, ii) estimates have been de-risked following 2020 guidance that embeds a 40% US Truck production cut, and iii) sentiment on vertical integration risk has turned overly negative, in our view.”
CMI’s analyst reviews show another deep split, this one with 4 Buys versus 8 Holds. The aggregate is a Moderate Buy consensus rating. The average price target of $187 indicates a 13% upside from the share price of $166. (See Cummins stock analysis at TipRanks)
AGCO Corporation (AGCO)
The third stock on our list, AGCO, is the one that Goldman Sachs says to avoid. AGCO is a major manufacturer of agricultural equipment, and owns several well-known brands in the segment: Challenger, Massey Ferguson, and Fend, among others. The company’s products include a wide range of tractors, combines, hay tools, and sprayers, and are mainly marketed to large-scale farms. AGCO has a $5 billion market cap and a worldwide customer base.
It also has seen earnings slip badly in 2H19. While the first half of last year saw quarterly reports rise sequentially and beat the estimates, the second half saw an opposite trend. Q4 was particularly bad in that respect, with the 94-cent EPS missing estimates by 39%. Revenue dropped sequentially from $2.59 billion to $2.51 billion, a 3% fall, and missed the quarterly forecast by 5.6%. Shares are down 8.6% since the earnings release.
With earnings falling, investor would normally look to the dividend for relief, but AGCO gives minimal relief there. The dividend, at just 64 cents annually, yields only 0.96%, less than half the average among S&P listed companies. Even Treasury bonds, at near-historic lows of just 1.5%, are offer a better yield at present than AGCO shares.
Revich, writing for Goldman on this stock, does not pull punches. He describes this company’s path forward as “unclear,” and downgrades the shares from Buy to Neutral. His 12-month price target of $70 implies a minimal upside of 4.8%.
In his comments on the stock, Revich highlights the risks that AGCO faces in the South American markets. He writes, “[O]ur belief that ag equipment share of farmer capex is still in the process of bottoming, coupled with the increasingly tightening levels of used ag equipment inventory, makes us view the ag end-market as well positioned for growth in the coming quarters. However, on a micro level, we no longer feel comfortable underwriting a margin recovery in South America where AGCO continues to face further risk of share loss.” (To watch Revich’s track record, click here)
Overall, AGCO is another Moderate Buy on the analyst consensus. The stock has 5 Buys, 6 Holds, and 1 Sell set in recent weeks. Shares are selling for $66.76, and the average target, $79.50, remains more bullish than Revich’s, suggesting a 19% upside. (See AGCO’s stock analysis at TipRanks)