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5 stocks for a long cycle
Early in a cyclical industry's recovery, it pays to own sector leaders. But as the cycle expands, it makes sense to turn to secondary stocks.
By Jim Jubak
The key to success in a cyclical industry is to go into the tough times with enough cash so that you can buy assets and customers of competitors that stumble. Then, when demand picks up, rake in the profits. The good times get even better, of course, if the top of the cycle lasts longer than expected. And thats just what were seeing for the makers of construction and farm equipment.
Look at Caterpillar (CAT, news, msgs). On Sept. 28, the worlds largest maker of construction equipment raised its 2004 projections again. It estimates revenue will grow by 30% this year, better than the previously projected 25%. Then there's Deere (DE, news, msgs) in the farm equipment sector. Its revenue grew by 25% in the year's first half, and it now looks like this cycle wont peak until 2006.
In the early stages of a cyclical industrys recovery, the stocks to own are the industry leaders. Investors know that they're certain bets to pick up more than their share of the profits, and theyre usually run by seasoned managers whove been through this up-and-down-and-up-again process before.
Thats why in 2003 you wanted to own Caterpillar, up 86% that year, and Deere, up 44%.
But if the cycle's peak stretches out longer than expected, secondary stocks often take over the stock market leadership. That's partly because a longer recovery phase of a cycle gives more companies a chance to participate. It's also because investors take profits on early gainers and put that money to work in sector laggards.
So this year you would've wanted to own Terex (TEX, news, msgs), up 50%, instead of Caterpillar, up 6%. Or CNH Global (CNH, news, msgs), up 43%, instead of Deere, up 4%. Its these secondary stocks in cyclical industries that have the momentum as we head into 2005, with the revenue and earnings peaks still a distance ahead.
The recommendations
I recommended three stocks that fit this bill in my 11:20 a.m. ET Wednesday appearance on CNBCs "Morning Call."
Terex barely managed to survive the last downturn in the construction equipment industry. But survive it did, largely by buying even more financially troubled equipment companies for rock-bottom prices. This strategy took Terex from an also-ran in its sector to the world's No. 3 behind Caterpillar and Japans Komatsu.
Terex was slow off the mark in 2002, showing a 36% stock price loss to Caterpillars 10% drop that year. Investors worried about the heavy debt load that the company had taken on to buy those failing competitors. They also fretted about whether Terex could make the transition from a bundle of separate companies to an integrated business that could capture the economies of scale so important to making a profit in the construction equipment sector.
Those doubts seem to have been put aside as the stock took off in 2003 and continued its run this year. Despite that huge run, the stock trades at a price-to-sales ratio of just 0.5 and a forward price-to-earnings ratio of just 18.3. That puts the companys price-to-earnings-to-growth ratio at one, substantially below the industry average of 1.4. Our StockScouter rated this stock a 6 out of a possible 10 on Oct. 13.
One big deal
CNH Global rings a few changes on the Terex story. Instead of bulking up by acquiring competitors, CNH came into being in 1999 through a single big deal when the New Holland farm equipment division of Italian car maker Fiat acquired Case. The companies managed to get the deal done just before falling farm incomes knocked the stuffing out of equipment sales.
Putting the two companies together hasnt been easy and the job isnt done yet. CNH plans to close another five factories in 2005. But results have shown an improvement with operating margins (before write downs for closing factories and cutting workers) up to 3.1% from a miniscule 1.5%. The companys target is 10% operating margins at the peak of the cycle. The stock sells for just 14.3 times projected 2004 earnings per share and shows a price-to-book ratio of 0.5 and a price-to-sales ratio of 0.2. Our StockScouter rated the shares a 6 out of a possible 10 on Oct. 13.
Ultimate acquisition story
AGCO (AG, news, msgs), the No. 3 farm equipment company behind Deere and CNH, is the ultimate acquisition story. The company has acquired more than 20 companies since it was founded in 1990, most recently the $800 million purchase of Finlands Valtra. All those deals have left AGCO with a huge restructuring job that has seen operating margins drop to 5.2% in 2003 from 10% in 1995. But the company believes that it can get margins back up to 7% by the time this cycle peaks.
AGCO trades for 14.4 times trailing-12-month earnings per share and 12 times projected 2004 earnings. Our StockScouter rated the shares 9 out of a possible 10 on Oct. 13.
As always I have two exclusive picks for CNBC.com on MSN readers. Actually, I've picked both before, Oshkosh Truck (OSK, news, msgs) on on April 21 and Paccar (PCAR, news, msgs) on May 19.
Shifting from defense
Oshkosh Truck got slammed Monday, creating a good buying opportunity. Before the drop, the shares had been selling near the top of their recent price channel and the decline pushed them to near the channel's bottom. The catalyst was news that the company hadnt been selected for a military vehicle contract worth close to $2 billion in the United Kingdom. While missing out on a contract is never good, this is exactly the kind of unpredictability that characterizes the defense industry and shows why, as Oshkosh has moved away from defense sales, its stock has climbed. Defense sales are now just 34% of total revenue, down from 83% in 1987.
Oshkosh takes a page out of the General Electric (GE, news, msgs) playbook and tries to be the leader in each of its markets. So Oshkosh dominates the heavy-defense truck market, holds the top market share in the fire equipment market and leads the cement truck segment. The shares trade at 19.1 times projected 2004 earnings per share and at a price-to-sales ratio of one. The price-to-earnings-to-growth ratio is just 1.3. Our StockScouter rated the shares a 10 out of a possible 10 on Oct. 13.
Riding the cycle
Paccar is the cyclical that proves the rule. Over time this company has proven that it knows how to ride the cycles. In the down cycles, Paccar always has plenty of cash when its competitors are struggling. It puts that dough to work investing in new production equipment and in research and development, so when the peak comes, the company takes market share just as customers start spending again. Thats why Paccar is the one early-stage cyclical star that I recommend for the entire cycle.
The stock trades at a 17.4 times trailing 12-month earnings and 13.6 times projected 2004 earnings. The price-to-sales ratio and the price-to-earnings-to-growth ratio are both 1.3. Our StockScouter rated the shares an 8 out of a possible 10 on Oct. 13.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Oshkosh Truck. He does not own short positions in any stock mentioned in this column.
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