Industrials Sector
Jason Kraynak and Wade Guzdanski
Agenda
 Overview
 Business Analysis
 Economic Analysis
 Financial Analysis
 Valuation Analysis
 Recommendation
Overview
Industrials
 Capital Goods
 Aerospace & Defense, Construction & Engineering, Electrical
Equipment, Building Products, Machinery, Trading & Distributors
 Commercial Services & Supplies
 Commercial Printing, Data Processing,
 Transportation
 Air Freight & Logistics, Airlines, Marine, Road & Rail,
Transportation Infrastructure
 Market Cap of $1.55 Trillion
Industrials Avg. % of S&P 500
Economic Sector
Total
Consumer Discretionary
Consumer Staples
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Telecommunication Services
Utilities
[Unassigned]
Holdings Data As Of
S&P 500 6/29/2012 through 5/31/2013
S&P 500
Average
Weight
100.00
11.21
11.01
11.01
15.20
12.12
10.05
19.13
3.46
3.13
3.56
0.13
Source: Factset
SIM Portfolio Weight – 6/23/2013
Sector
S&P 500
Weight
SIM Weight
+/-
Consumer Discretionary
12.10%
12.93%
0.83%
Consumer Staples
10.50%
13.54%
3.04%
Energy
10.60%
14.15%
3.55%
Financials
16.60%
14.11%
-2.49%
Health Care
12.80%
12.17%
-0.63%
Industrials
10.20%
7.86%
-2.34%
Information Technology
17.80%
17.34%
-0.46%
Materials
3.30%
1.71%
-1.59%
Telecommunication Services
2.80%
2.00%
-0.80%
Utilities
3.30%
3.96%
0.66%
Cash
0.00%
0.22%
0.22%
 Industrials account for 10.7% of S&P 500, portfolio is currently underweight
234bps
Current SIM Holdings
Security
Caterpillar Inc.
Joy Global Inc.
Quantity
5,700
6,050
Unit Cost
103.56
57.46
Total Cost
$590,283.72
$347,639.05
Market
Price
85.80
54.08
6,200
51.34
$318,283.07
61.82
Market Value
$489,060.00
$327,184.00
$383,284.00
Unrealized
Gain/(Loss)
($101,224)
($20,455)
SOLD
Danaher Corp.
 Shares in Danaher Corporation were sold as part of move to reduce
portfolio to $10M prior to fiscal year-end
$65,001
Sector Industries
Sector Industries
Commercial Services
Consumer Durables
Distribution Services
Electronic Technology
Finance
Health Services
Health Technology
Industrial Services
Producer Manufacturing
Transportation
Total
Number of
Securities
7
2
2
8
1
1
1
5
25
9
61
Ending
Market
Weight Capitalization
3.5%
9,434.1
1.2%
10,610.0
2.0%
16,746.0
14.2%
41,266.3
0.2%
3,273.2
0.6%
9,463.3
0.5%
7,609.3
3.5%
13,044.7
57.1%
102,438.2
17.0%
50,538.4
100.0%
74,350.8
Price/
YTD Total
1 Year
Earnings
Return Total Return
33.3
9.4%
30.3%
23.0
10.2%
30.4%
30.0
20.2%
27.9%
14.8
20.6%
36.0%
15.0
27.6%
49.6%
34.5
17.7%
25.8%
13.7
14.0%
24.4%
21.5
18.3%
36.6%
16.1
13.1%
27.8%
21.8
18.6%
23.3%
17.5
15.2%
28.5%
 88% of sector is comprised of three industries: Electronic Technology, Producer
Manufacturing and Transportation
Largest Companies
Rank
1
2
3
4
5
6
7
8
9
10
Security
General Electric Co.
United Technologies Corp.
Union Pacific Corp.
3M Co.
Boeing Co.
Honeywell International Inc.
United Parcel Service Inc.
Caterpillar Inc.
Emerson Electric Co.
Danaher Corp.
Ticker
GE
UTX
UNP
MMM
BA
HON
UPS
CAT
EMR
DHR
Market
Cap. ($)
241,131.6
87,241.6
72,228.9
76,107.8
75,089.0
61,731.1
81,089.6
56,412.2
41,412.0
48,219.6
Ending
Weight
16.4%
5.4%
4.9%
4.7%
4.6%
4.2%
4.2%
3.8%
2.8%
2.4%
Industrials Performance
Multi-Horizon Chart: Annualized Return
30
06/2010 to 05/2013
25
20
15
10
5
1 Month
QTD
S&P Industrials - Total Return
Description
1 Quarter
2 Quarter
3 Quarter
YTD
1 Year
2 Year
3 Year
Entire Period
S&P 500 - Total Return
1 Month
S&P Industrials - Total Return
4.93
S&P 500 - Total Return
2.34
QTD
4.12
4.31
1Q
6.40
8.22
2Q
18.17
16.43
3Q
21.57
17.91
YTD
15.23
15.37
1 Year
28.47
27.28
2 Year
10.24
12.58
3 Year
16.26
16.87
Period
16.26
16.87
Business Analysis
Industrials Life Cycle
 Industrials sector is in the
“Maturity” phase
 Slow stable growth, consistent with
overall economy
 Consistent returns and cash flow
 Low number of new entrants
 Dominated by a few large companies
Business Cycle Impact
 As the economy improves,
companies increase capital
spending in response to higher
demand for products
 Leads to expansion in production
capacity
 Global sector
 Significant influence from domestic
and international economies
 Growth focused in emerging
markets
Catalysts & Risks
 Catalysts
 Europe coming out of their recession
 Turnaround in China
 Growth in emerging markets
 Risks
 Lower government spending
 Strengthening US Dollar
 Uncertainty regarding monetary policy
 Slow global growth forecast
Porter’s Five Forces
Force
Impact to Sector
Details
Barriers to Entry
High (+)
Substitutes
Moderate (-/+)
Buyer Power
Low to Moderate (+)
Supplier Power
Low to Moderate (+)
Rivalry
Moderate (-/+)
- High start up costs
- Significant capital requirement
- High level of strength from a limited number of brands
- Economies of scale (major established brands)
- Switching costs are low
- Unspecialized products can be replicated
- Substitutes have low performance
- Low level of buyer concentration
- Competition between buyers
- Limited number of major brands
- Products are relatively critical to buyer
- Switching costs are low
- Sector dominated by a few large companies (require large
volume)
- High level of substitutes
- Inputs relatively consistent across industry
- Several dominate global brands
- High level of preproduction costs, fuels price competition
Economic Analysis
Industrials Drivers
 High Correlation to overall equity market
 Production & Manufacturing
 GDP
 Unemployment
 Crude Oil
 Housing
Industrials & S&P 500 highly correlated
10 Years
Industrials
S&P 500
Industrials & S&P 500 highly correlated
5 Years
Industrials
S&P 500
Industrials & S&P 500 highly correlated
2 Years
Industrials
S&P 500
Industrial Production

Measures real output of manufacturing, mining, and electric and gas utilities

Industrials sector accounts for the bulk of the variation

Manufacturing very soft based on May data.

Excluding motor vehicles, manufacturing rose only 0.1% in May

Capacity utilization decreased to 77.6% in May from 77.7% in April
Data source: Haver Analytics
Durable Goods Orders

Reflect new orders placed with domestic manufacturers for immediate and future delivery of factory hard
goods

Extremely volatile

Up 3.6% in May

Transportation up 10.2%, making up most of the gains
Data source: Haver Analytics
ISM Manufacturing Index

Survey of 300 manufacturing firms: employment, production, new orders, deliveries, inventories

>50 = expanding

Strength from new orders and export orders

Weaknesses from employment, inventories, and prices

Slow growth
<50 = contracting
currently 50.9
Data source: Haver Analytics
GDP

Revised down to 1.8% from 2.4% led down by personal consumption

Headline inflation at 1.2%

Economic Growth marginally positive in Q1 with low inflation

What will the Fed do?
Data source: Haver Analytics
Unemployment
Data source: Haver Analytics
Crude Oil – Highly Correlated
5 Years
Housing – Existing Home Sales

Up 4.2% to annual sales rate of 5.18 million, highest since late 2009

Median price up 8.4% in May to $208,000
mean $255,300
Data source: Haver Analytics
Housing – New Home Sales

Up 2.3% to annual rate of 454,000

Median price up 8.3% in May to $271,600
mean $330,800
Data source: Haver Analytics
Housing – Housing Starts

We need equipment, tools, and material to build!

Thank you Ben Bernanke!
Data source: Haver Analytics
Financial Analysis
Revenue Growth Slow & In-Line with S&P 500
Revenue Growth
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
2006
2007
2008
2009
2010
2011
2012
-10.0%
-15.0%
-20.0%
S&P 500
Industrials
 5 Year CAGR: Industrials Sector 2.7%, S&P 500 2.5%
2013E 2014E
Margin Growth Lags S&P 500
Operating Margin Percentage
Net Profit Margin Percentage
22.0%
40.0%
30.0%
20.0%
20.0%
18.0%
10.0%
0.0%
16.0%
-10.0%
14.0%
-20.0%
12.0%
-30.0%
2006
2007
2008
S&P 500
2009
2010
2011
2012
2006
2007
2008
2009
2010
2011
-40.0%
Industrials
 Industrials sector operating margin lags S&P 500
 5 Year CAGR: Industrials Sector -0.7%, S&P 500 0.9%
 Mixed results in net profit margin
 5 Year CAGR: Industrials Sector 2.5%, S&P 500 3.5%
S&P 500
Industrials
2012
2013E 2014E
Significant R&D and Capex Spend
Capex as a Percent of Sales
R&D as a Percent of Sales
3.8%
7.0%
3.6%
6.5%
3.4%
6.0%
3.2%
3.0%
5.5%
2.8%
5.0%
2.6%
4.5%
2.4%
4.0%
2.2%
2006
2007
2008
S&P 500
2009
2010
2011
2012
2006
Industrials
2007
2008
S&P 500
2009
2010
Industrials
 Increase in R&D spend as a percent of sales
 5 Year CAGR: Industrials Sector 2.2%, S&P 500 -2.9%
 Capital intensive industry, capex as a percent of sales is increasing but
trailing S&P on percent growth
 5 Year CAGR: Industrials Sector -0.7%, S&P 500 0.6%
2011
2012
ROE is a Concern, but Rebounding
Return on Equity
Return on Assets
30.0%
10.0%
8.0%
25.0%
6.0%
20.0%
4.0%
15.0%
2.0%
0.0%
10.0%
2006
2007
2008
S&P 500
2009
2010
2011
2012
2006
Industrials
 Industrials sector operating margin lags S&P 500
 5 Year CAGR: Industrials Sector -2.2%, S&P 500 3.7%
 Mixed results in net profit margin
 5 Year CAGR: Industrials Sector 7.9%, S&P 500 -0.6%
2007
2008
S&P 500
2009
2010
Industrials
2011
2012
Consistent Generated of FCF, Lags S&P 500
Free Cash Flow Per Share
120.0
100.0
80.0
60.0
40.0
20.0
2006
2007
2008
S&P 500
2009
2010
2011
Industrials
 5 Year CAGR: Industrials Sector -1.1%, S&P 500 23.4%
2012
Valuation Analysis
Industrials Valuation
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
Median Current
7.1
17.6
16.4
9.2
16.0
15.1
1.4
3.0
3.0
0.6
1.3
1.3
6.0
10.7
11.2
Relative to S&P 500 High
Low
P/Trailing E
1.20
P/Forward E
1.20
P/B
1.30
P/S
1.10
P/CF
14.00
Median Current
0.66
1.10
1.00
0.84
1.00
1.00
0.90
1.10
1.20
0.80
1.00
0.90
6.00
10.70
11.20
24.0
20.9
3.6
1.6
14.0
Industrials Valuation
Conglomerates
Const/Farm Mach
Aerospace / Def
Railroads
Air /Freight
Electrical
Absolute Basis Median Current Median Current Median Current Median Current Median Current Median Current
P/Trailing E
17.0
16.3
14.2
11.5
15.4
15.2
16.4
16.1
19.9
18.1
19.8
17.0
P/Forward E
16.2
14.9
13.0
11.6
14.5
14.1
14.6
14.9
18.2
16.1
17.5
15.3
P/B
2.9
2.3
4.0
3.1
3.2
3.7
2.2
3.1
4.2
4.9
3.8
2.9
P/S
1.8
1.8
1.0
0.9
1.0
1.1
2.0
2.7
1.2
1.0
1.8
1.9
P/CF
10.6
10.8
8.8
7.9
10.9
11.4
9.0
11.1
11.9
11.2
13.2
12.4
Rel. S&P 500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
Conglomerates
Const/Farm Mach
Aerospace / Def
Railroads
Air /Freight
Electrical
Median Current Median Current Median Current Median Current Median Current Median Current
1.1
1.0
0.9
0.8
1.0
1.0
1.0
1.1
1.3
1.2
1.2
1.1
1.0
1.0
0.9
0.8
1.0
1.0
1.0
1.0
1.3
1.1
1.1
1.1
1.0
0.9
1.4
1.3
1.2
1.6
0.9
1.3
1.5
2.1
1.5
1.3
1.3
1.3
0.7
0.7
0.7
0.8
1.5
2.0
0.9
0.7
1.2
1.3
1.1
1.0
0.9
0.8
1.1
1.1
0.9
1.1
1.2
1.1
1.3
1.2
Recommendation
Recommendation
 Currently -234bps underweight
 We recommend no change in weighting of industrials
 Reasons for concern

Slow global growth

GDP forecasts

Economy is still early in recovery phase

Foreign political uprisings

Low growth potential – valuation suggests sector is inline
 Why we may be wrong

Recent housing recovery

Possible energy independence (lower production costs = higher margins)

Faster economic expansion

Consumer sentiment
Questions?