STOCK ANALYSIS- INDUSTRIALS SECTOR
GARRETT GANDEE, SHI TING GU, STEVEN ROEHLIG
The Ohio State
University: SIM
Program
FIN 824 - Industrials Sector Overview





FIN 824 - Industrials Sector Overview

   Sector Size
   Market Cap = 1.2 Trillion
   Industries
   Air Freight & Logistics
S&P Sectors
   Airlines
   Building Products
   Commercial Printing
   Construction / Engineering
   Electrical Components
   Industrial Conglomerates
Industrials
   Railroads
   Industrial & Construction Machinery
   Data Processing, Environmental Services
   Farm Machinery
FIN 824 - Industrials Sector Overview

2/7/2012 – Despite “Increase to Market Weight” recommendation by industrials
team, class voted to maintain current underweight status.
FIN 824 - Industrials Sector Overview

•   2.23% of SIM Portfoloio
•   Unit Cost $77.76
•   Current Price $83.78 (8%)
•   3.98% of SIM Portfolio
•   Unit Cost $97.17
•   Current Price $118.56 (22%)
•   3.57% of SIM Portfolio
•   Unit Cost $50.53
•   Current Price $52.43 (4%)
FIN 824 - Industrials Sector Overview

•   2.23% of SIM Portfoloio
•   Unit Cost $77.76
•   Current Price $83.76 (8%)
•   Target Price $85.00 (1% Upside)
•   3.98% of SIM Portfolio
•   Unit Cost $97.17
•   Current Price $118.56 (22%)
•   Target Price $111.14 (-6%)
•   3.57% of SIM Portfolio
•   Unit Cost $50.53
•   Current Price $52.43 (2%)
•   Target Price $56.40 (7.6% Upside)

   United Technologies Corporation provides technology products and services to the building systems and aerospace industries worldwide.
   Business Consists of Six Segments:
   Otis segment designs, manufactures, sells, and installs passenger and freight elevators, escalators, and moving walkways, as well as provides maintenance and repair services.
   Carrier segment offers heating, ventilating, air conditioning, and refrigeration systems, controls, services, and energy-efficient products
   UTC Fire and Security segment provides electronic security products comprising intruder alarms, and access control and video surveillance systems
   Pratt and Whitney segment supplies aircraft engines for the commercial, military, business jet, and general aviation markets
   Hamilton Sundstrand segment supplies aerospace products and industrial products
   Sikorsky segment manufactures military and commercial helicopters
FIN 824 - Industrials Sector Overview

FIN 824 - Industrials Sector Overview

   52 Week Range: $91.83 - $66.87
   Current Price: $83.78 (2/17/2012)
   Our Target Price: $85.00 (1% Undervalued)
   Standard & Poor’s “Fair Value Calculation”
   Key Business Drivers
   Defense Spending, Aerospace, New Construction (Otis, Carrier)
   Review of ROE for UTX
ROE
1 Year
24.84
3 Years 5 Years
22.41 22.85
FIN 824 - Industrials Sector Overview
9 Years
22.42

UTX
Analyst: Shi Ting Gu
Date: 01/23/12
Year
Terminal
Discount
Rate = 10.5%
Terminal
FCF
Growth = 3.0%
2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E
Revenue
% Growth
Operating Income
Operating Margin
Interest and Other
Interest % of Sales
Taxes
Tax Rate
58,432 62,090 71,025
6.3%
73,866
14.4% 4.0%
76,082 78,365
3.0%
80,716
3.0%
83,137
3.0%
85,631
3.0% 3.0%
88,200 90,846
3.0% 3.0%
7,685 8,469 9,772 10,329 10,639 10,959 11,287 11,626 11,975 12,334 12,704
13.2% 13.6% 13.8% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0%
526 745 845 591 609 627 646 665 685 706 727
0.9% 1.2% 1.2% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8%
1,933 2,240 2,392 2,610 2,688 2,769 2,852 2,938 3,026 3,116 3,210
27.0% 29.0% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8% 26.8%
Net Income
% Growth
Add Depreciation/Amort
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
4,926 5,146 6,215 7,069 7,282 7,503 7,730 7,963 8,204 8,452 8,707
4.5% 20.8% 13.7% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
1,300
2.2%
-1.8%
900
1.5%
1,400
2.3%
1,500
2.1%
1,699
2.3%
1,750
2.3%
1,802
2.3%
1,856
2.3%
1,912
2.3%
1,970
2.3%
2,029
2.3%
2,089
2.3%
(1,078) (600) (1,965) (1,256) (1,293) (1,332) (1,372) (1,413) (1,456) (1,499) (1,544)
-1.0% -2.8% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7% -1.7%
950 1,000 1,108 1,141 1,175 1,211 1,247 1,284 1,323 1,363
1.5% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%
Free Cash Flow
% Growth
NPV of Cash Flows
NPV of terminal value
Free Cash Flow Yield
Projected Equity Value
4,248 4,995 4,749 6,404 6,598 6,797 7,003 7,215 7,433 7,658 7,890
17.6% -4.9% 34.8% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
38,511 49%
39,922
78,433
51%
100%
Terminal
Value 108,352
5.50%
Free Cash
Yield 7.28%
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
15.7
15.9
12.2
12.3
15.0
15.2
11.1
11.2
12.4
12.6
9.7
9.8
Terminal
P/E 12.4
Terminal
EV/
EBITDA 9.5
Shares Outstanding 923
Current Price $ 83.78
Implied equity value/share $ 85.00
Upside/(Downside) to DCF 1.5%
Debt
Cash
Cash/share
38,033
5,966
6.47
FIN 824 - Industrials Sector Overview

FIN 824 - Industrials Sector Overview

Our Target: $85.00
FIN 824 - Industrials Sector Overview

   Company’s performance greatly affected by foreign market.
Sales for 2011 from outside the United States were 61% of its total segment sales.
   Potential reduction in military demand: U.S. pulled out army force from Iraq in 2011, and President Barack Obama is signaling he wants to get out of Afghanistan.
FIN 824 - Industrials Sector Overview

ADDITIONAL UTX CONCERNS
   In September 2011, UTX acquired Goodrich Corp for $18.4 billion which is a global supplier of systems and services to the aerospace and defense industry.
   Economist criticized that UTX was paying too much to buy GR when the market is in a far worse shape.
   This acquisition will not be accretive to profit at least until fiscal 2013. But expected revenue 2012 will still be in the range of estimated revenue 2012.
FIN 824 - Industrials Sector Overview

   Global manufacturer of industrial pumps and related equipment for the chemical, oil, gas, and power industries
   Market Cap: $6.587 Billion
   Sub-Industry: Industrial Machinery
FIN 824 - Industrials Sector Overview

JUSTIFICATION – SELL 50% FLS
   52 Week Range: $135.72 - $66.84
   Current Price: $118.56
   Our Target Price: $111.14 (6% Overvalued)
   Standard & Poor’s “Fair Value Calculation”
   Key Business Drivers
   Capital Expenditures in Oil & Gas, Chemicals, and General Industrials
   Review of ROE for FLS
ROE
1 Year
19.94
3 Years 5 Years
26.75 22.90
FIN 824 - Industrials Sector Overview
9 Years
15.50

FIN 824 - Industrials Sector Overview

JUSTIFICATION – SELL 50% FLS
•   Price ratio valuation
FIN 824 - Industrials Sector Overview

JUSTIFICATION – SELL 50% FLS
FIN 824 - Industrials Sector Overview
Our Target: $111.14

JUSTIFICATION- SELL 50% FLS
   Time to take profits off the table. FLS has returned 22% over its unit cost of $97.17.
   FLS is currently 6% over our target price of $111.14
   However, our model differs greatly from analysts’ consensus estimates
(target of $135 - $145).
   Flowserve is highly correlated with the price of oil. ( )
   Increased capital expenditures on oil and gas in the US (shale plays), and in emerging markets will benefit FLS. ( )
   Let’s keep 50% of our FLS shares in the game.
FIN 824 - Industrials Sector Overview

   Designs, manufactures and markets professional, medical, industrial and commercial products and services.
   Operates in five business segments:
   Test & Measurement
   Environmental
   Life Sciences & Diagnostics
   Dental
   Industrial Technologies
   Growth is derived from segment core expansion and frequent external acquisitions.
FIN 824 - Industrials Sector Overview


   Increasing sales in foreign markets, notably those with growing economies.
   Strong sales and margin growth, including digit core margin growth in Industrial Technologies and
Test & Measurement segments. Margins now above 20% in both segments.
   Gross margin has been higher than its industry average for each of the past five years.
   The company has targeted acquisitions of companies with gross margins above 50%.
FIN 824 - Industrials Sector Overview

   52 Week Range: $56.09 - $39.34
   Current Price: $52.43
   Our Target Price: $56.40 (7.6% Undervalued)
   Standard & Poor’s “Fair Value Calculation”
   Key Business Drivers
   Segment core expansion and frequent external acquisitions
   Review of ROE for DHR
ROE
1 Year
12.64
3 Years
12.51
5 Years
13.38
9 Years
15.42
FIN 824 - Industrials Sector Overview

FIN 824 - Industrials Sector Overview

FIN 824 - Industrials Sector Overview

•   Price ratio valuation
FIN 824 - Industrials Sector Overview

Our Target: $56.41
FIN 824 - Industrials Sector Overview

•   On 1/31/12, the company announced quarterly earnings of 0.81 per share, a positive surprise of 3.5% above the consensus 0.78.
•   Over the past 4 quarters, the company has reported 4 positive, 0 negative, and 0 in-line surprises.
FIN 824 - Industrials Sector Overview

   Over 70% of sales growth in the last 5 years has come from acquisitions.
   Increasing sales in foreign markets may slow down with rising concern in foreign markets.
FIN 824 - Industrials Sector Overview

Industry
Diversified  Machinery
Aerospace  and  Defense  Products  and  Services
Industrial  Electrical  Equipment
Farm  &  Construc@on  Machinery
Industrial  Equipment  &  Components
Waste  Management
General  Building  Materials
Metal  Fabrica@on
Aerospace  &  Defense  –  Major  Diversified
Heavy  Construc@on
Residen@al  Construc@on
Machine  Tools  &  Accessories
Small  Tools  &  Accessories
Cement
General  Contractors
Tex@le  Industrial
Pollu@on  &  Treatment  Controls
Lumber,  Wood  Produc@on
Manufactured  Housing
FIN 824 - Industrials Sector Overview

   A large number of the industries we assigned a positive outlook to will greatly benefit from an upturn in new construction
Construction Sub-
Industries
   BUILDING MATERIALS
   FARM & CONSTRUCTION
MACHINERY
   RESIDENTIAL CONSTRUCTION
   CEMENT
   GENERAL CONTRACTORS
   LUMBER/WOOD PRODUCTION
   MANUFACTURED HOUSING
FIN 824 - Industrials Sector Overview

   Of those sub-industries, our recommendation would be to target Construction & Farm Machinery & Heavy
Trucks.
   Improving global economy since 2010
   Global nonresidential construction markets are improving
   Domestic housing market bottoming
   Robust construction growth in emerging nations
   Aging equipment in mature economies
   Farm income (primary driver for agricultural equipment sales, rose by 28% in 2011.
FIN 824 - Industrials Sector Overview

NEW STOCK RECOMMENDATION
   Caterpillar, Inc. is the world’s largest producer of earthmoving equipment, and a big maker of electric power generators and engines used in petroleum markets, and mining equipment
   Caterpillar construction machines are in service in nearly every country in the world. 65% of sales derived outside North
America.
FIN 824 - Industrials Sector Overview

NEW STOCK RECOMMENDATION
   Current Price: $113.95
   52-Week Range: $116.55 - $67.64
   Market Capitalization: $72.26 Billion
   Our Target: $136.78 (20% Upside)
   S&P “Fair Value Calculation”
FIN 824 - Industrials Sector Overview

NEW STOCK RECOMMENDATION
FIN 824 - Industrials Sector Overview

NEW STOCK RECOMMENDATION
FIN 824 - Industrials Sector Overview
Our Target: $136.78

FIN 824 - Industrials Sector Overview

•   Price ratio valuation
FIN 824 - Industrials Sector Overview

SIM INDUSTRIALS PORTFOLIO CHANGES
   Class Voted to Keep Industrials Sector Underweight, and stay at 9.78% of total SIM portfolio.
   SELL 223 bps of UTX (100% of UTX in SIM Portfolio)
   SELL 200 bps of FLS (50% of FLS in SIM Portfolio)
   BUY 423 bps of CAT
   HOLD 198 bps of FLS
   HOLD 357 bps of DHR
SIM Industrials Weight
10%
Industrials
90%
Rest of
Portfolio
FIN 824 - Industrials Sector Overview

Old Holdings
SIM Industrials
New Holdings
SIM Industrials
36%
23%
41%
UTX
FLS
DHR
37%
20%
43%
CAT
FLS
DHR
FIN 824 - Industrials Sector Overview

RECOMMENDATIONS SUMMARY- INDUSTRIALS
   SELL 223 bps (ALL) of
   SELL 200 bps (HALF) of
   BUY 423 bps of
   HOLD Current Position of
   HOLD 198 BPS of
FIN 824 - Industrials Sector Overview