Morningstar Advisor - June/July 2009 - 58

Sector Rap Long-Term Investors Can Find Value among Industrials By Haywood Kelly Morningstar’s industrials team looks beyond today to find value for the future. When the economy sneezes, industrials catch the flu. Of course, today’s global economy has come down with something between whooping cough and tuberculosis, so we’re not sure exactly where that leaves industrials stocks. To find out, we’re talking with several key members of Morningstar’s equity research team: Adam Fleck, a senior analyst who covers 3M MMM and a variety of transportation firms; Daniel Holland, an analyst covering such stocks as General Electric GE, Honeywell HON, and Danaher DHR; and John Kearney, a senior analyst covering Caterpillar CAT, Deere DE, and Illinois Tool Works ITW, among others. Haywood Kelly: The industrials sector is Motors GM and suppliers like American Axle AXL—will face substantial financing challenges, well-capitalized dealerships like CarMax KMX look attractive. HK: For these companies, are you modeling a bottom in 2010? AF: We don’t expect this recession to last broad, to say the least. Some companies feel a cyclical downturn immediately, others only after a significant lag. Which firms are furthest along the downward curve? Adam Fleck: The homebuilding and land transportation industries have been feeling the pain for some time and were hit very hard as the economy turned sour. As the economy eventually picks up, we’d expect these industries to enjoy early success, and a company such as FedEx FDX could benefit. Somewhat similar, auto manufacturing dropped in early 2008 and may see a healthy recovery because of underproduction. While we think many of the companies in this industry— including manufacturers such as General forever. At a certain point, there will be a recovery, and we’re expecting some positive signs through 2010 in our base-case modeling. To put it simply, these companies are operating at rates far below our estimate of normalized demand. For example, we think housing formation and replacement spending suggest a natural rate of demand near 1.5 million homes annually. The industry looks to build less than half a million homes this year. Although the inventory of for-sale homes may prevent a rapid recovery, we think the current rate of production is simply unsustainably low. However, we caution that near- to medium-term housing demand is highly dependent upon job creation, something that’s definitely not a tail wind right now. HK: What’s your pessimistic scenario? And how recovery pushed out to 2011. This time frame varies by the end markets for the companies, with those closer to consumers coming back a little sooner in pessimistic scenarios than companies selling to other industrial companies. For companies whose pessimistic scenarios result in debt-covenant violations or a hint of financial distress, we factor in the likelihood of a possible bankruptcy or a dilutive capital infusion. In healthier companies, we use the pessimistic scenarios to assess if our uncertainty rating is in line with the range of possibilities for the firm. HK: What companies, if any, are on your death watch list—meaning they may not come out the other side, at least as currently structured? DH: Auto manufacturers and suppliers are at the top of the list right now. When consumers stopped buying cars en masse, the manufacturers had a tough time covering the cost of the labor force. The auto suppliers were weak before the manufacturers went south, and now they are faced with low volumes and financially distressed customers. Companies like American Axle and Lear LEA may not make it to the other side as currently structured. In general, industries that operate on leverage are getting weaker. Dry bulk shippers, including bellwether DryShips DRYS, and other marine transport firms are in a tight spot, as are some airlines. do you factor a pessimistic scenario into your fair value estimates? Daniel Holland: Our pessimistic scenarios take the downturn deeper into 2010, with a 58 Morningstar Advisor June/July 2009

Morningstar Advisor - June/July 2009

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2009

Morningstar Advisr - June/July 2009
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
Is SRI a Relevant Investment Strategy?
A Head for Numbers
Building a Business on SRI
Investment Briefs
The Liquidity Premium
Navigating the SRI Patchwork
Profit and Progress
How the Fed Contributes to Crises
Holding Steady
Appleseed Adds Value to SRI Formula
Four Picks for the Present
Long-Term Investors Can Find Value among Industrials
Higher Yields, Hold the Risk
Bargains in U.S. Industrials
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
Talkin’ ‘bout a Revolution
Morningstar Advisor - June/July 2009 - 47
Morningstar Advisor - June/July 2009 - Morningstar Advisr - June/July 2009
Morningstar Advisor - June/July 2009 - Cover2
Morningstar Advisor - June/July 2009 - Contents
Morningstar Advisor - June/July 2009 - 2
Morningstar Advisor - June/July 2009 - 3
Morningstar Advisor - June/July 2009 - New on MorningstarAdvisor.com
Morningstar Advisor - June/July 2009 - 5
Morningstar Advisor - June/July 2009 - 6
Morningstar Advisor - June/July 2009 - Letter from the Editor
Morningstar Advisor - June/July 2009 - Contributors
Morningstar Advisor - June/July 2009 - 9
Morningstar Advisor - June/July 2009 - Is SRI a Relevant Investment Strategy?
Morningstar Advisor - June/July 2009 - 11
Morningstar Advisor - June/July 2009 - A Head for Numbers
Morningstar Advisor - June/July 2009 - 13
Morningstar Advisor - June/July 2009 - 14
Morningstar Advisor - June/July 2009 - Building a Business on SRI
Morningstar Advisor - June/July 2009 - 16
Morningstar Advisor - June/July 2009 - 17
Morningstar Advisor - June/July 2009 - Investment Briefs
Morningstar Advisor - June/July 2009 - 19
Morningstar Advisor - June/July 2009 - 20
Morningstar Advisor - June/July 2009 - 21
Morningstar Advisor - June/July 2009 - 22
Morningstar Advisor - June/July 2009 - The Liquidity Premium
Morningstar Advisor - June/July 2009 - 24
Morningstar Advisor - June/July 2009 - 25
Morningstar Advisor - June/July 2009 - 26
Morningstar Advisor - June/July 2009 - 27
Morningstar Advisor - June/July 2009 - 28
Morningstar Advisor - June/July 2009 - 29
Morningstar Advisor - June/July 2009 - Navigating the SRI Patchwork
Morningstar Advisor - June/July 2009 - 31
Morningstar Advisor - June/July 2009 - 32
Morningstar Advisor - June/July 2009 - 33
Morningstar Advisor - June/July 2009 - 34
Morningstar Advisor - June/July 2009 - Profit and Progress
Morningstar Advisor - June/July 2009 - 36
Morningstar Advisor - June/July 2009 - 37
Morningstar Advisor - June/July 2009 - 38
Morningstar Advisor - June/July 2009 - 39
Morningstar Advisor - June/July 2009 - How the Fed Contributes to Crises
Morningstar Advisor - June/July 2009 - 41
Morningstar Advisor - June/July 2009 - 42
Morningstar Advisor - June/July 2009 - 43
Morningstar Advisor - June/July 2009 - 44
Morningstar Advisor - June/July 2009 - 45
Morningstar Advisor - June/July 2009 - 46
Morningstar Advisor - June/July 2009 - 47
Morningstar Advisor - June/July 2009 - Holding Steady
Morningstar Advisor - June/July 2009 - 49
Morningstar Advisor - June/July 2009 - 50
Morningstar Advisor - June/July 2009 - 51
Morningstar Advisor - June/July 2009 - Appleseed Adds Value to SRI Formula
Morningstar Advisor - June/July 2009 - 53
Morningstar Advisor - June/July 2009 - 54
Morningstar Advisor - June/July 2009 - 55
Morningstar Advisor - June/July 2009 - Four Picks for the Present
Morningstar Advisor - June/July 2009 - 57
Morningstar Advisor - June/July 2009 - Long-Term Investors Can Find Value among Industrials
Morningstar Advisor - June/July 2009 - 59
Morningstar Advisor - June/July 2009 - 60
Morningstar Advisor - June/July 2009 - 61
Morningstar Advisor - June/July 2009 - Higher Yields, Hold the Risk
Morningstar Advisor - June/July 2009 - 63
Morningstar Advisor - June/July 2009 - Bargains in U.S. Industrials
Morningstar Advisor - June/July 2009 - 65
Morningstar Advisor - June/July 2009 - Mutual Fund Analyst Picks
Morningstar Advisor - June/July 2009 - 67
Morningstar Advisor - June/July 2009 - 68
Morningstar Advisor - June/July 2009 - 69
Morningstar Advisor - June/July 2009 - 50 Most Popular Equity ETFs
Morningstar Advisor - June/July 2009 - 71
Morningstar Advisor - June/July 2009 - Undervalued Stocks
Morningstar Advisor - June/July 2009 - 73
Morningstar Advisor - June/July 2009 - 74
Morningstar Advisor - June/July 2009 - 75
Morningstar Advisor - June/July 2009 - Most Popular Variable Annuities
Morningstar Advisor - June/July 2009 - 77
Morningstar Advisor - June/July 2009 - 78
Morningstar Advisor - June/July 2009 - New at Morningstar
Morningstar Advisor - June/July 2009 - Talkin’ ‘bout a Revolution
Morningstar Advisor - June/July 2009 - Cover3
Morningstar Advisor - June/July 2009 - Cover4
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