Morningstar Advisor - December 2010/January 2011 - (Page 28)

Sector Rap Things Fall Apart, Even in Industrials By Philip Guziec Wear, tear, and competition will drive a comeback in this sector. The third quarter of 2010 was good for industrials, and looking out a bit further, our analysts are still optimistic about industrial demand. In November, I sat down with some of Morningstar’s industrials team to discuss the reasons for their optimism. Q: What kind of operating performance are we seeing in the industrials at this point in the economic recovery, and what’s the outlook for the next year and going forward? Adam Fleck: So far, in the general industrial in farm equipment—the farm income numbers here in North America are looking pretty good. Shortages of wheat due to drought in Russia and the fact that the crop yields here in the U.S. are down are both pushing up prices of crops. These are key inputs that should lead to increased purchase activity this year and especially next year. Daniel Holland: One thing I’d add is that we’re seeing a normal behavior in a recovery. A couple of quarters ago, we started seeing the shorter-cycle end-markets improve with more of the consumable products. Now we’re starting to see more of the capitalintensive goods come into favor, with order growth rates getting back into double digits. For example, in the automation and control environment, companies are actually spending money to improve their own infrastructure. This is a normal cadence to how the industrials swing back into things. a single-digit-growth or no-growth environment. Rick Tauber: On the weakness side, I would say that the defense sector is weak. It’s pretty well telegraphed and priced into the market, but as an example, Level 3 Communications LVLT recently reported earnings; they cut their revenue estimates for this year and for next year and lowered their earnings targets for next year—they’re seeing much more competition on the defense side, as well as margin pressure. But the stock was basically flat on the news, so a lot of that is priced in, as it was pretty welltelegraphed by the U.S. Department of Defense. Fleck: I would also like to highlight Daniel’s point about the short-cycle products. 3M is a great example; most of their orders are going to be filled within 30 days, and this offers us a pretty good view of where we are in the industrial economy. Their organic growth for the first two quarters has been very strong, near 20%. It dipped a little bit in the third quarter because of some tougher year-overyear comparable sales, but we’re seeing great growth in areas like sandpaper, other abrasives, automotive original equipment—all across the industrial spectrum. We’re also seeing a lot of companies that supply the consumer electronics space enjoy some pretty heady results as consumer spending and confidence comes back. 3M is a great example space, the outlook has been the strongest in emerging economies, like those in Latin America and China; that’s not too surprising. We’ve seen some good bounce-back in a number of industries that were beaten down severely last year here in North America. Europe has generally seen a weaker recovery, but areas like Germany are probably a little bit stronger, as we’ve heard from companies like 3M MMM. Eastern Europe and Russia particularly continue to suffer. Q: How about across categories of industrials? Where are we seeing strength, and where are we seeing weakness? Fleck: We’re seeing strength in heavy equipment, particularly again in emerging economies and even here in North America. We’ve also seen a pretty good pickup The other element that I’d add is that while Europe is not necessarily as strong as the other markets, it’s nowhere near as bad as what folks were predicting in May/June of last year when you had the Greece crisis. At that point many people thought that Europe was going down and taking the rest of the world with it. Europe’s OK. It’s not great, but it’s manageable, and a lot of companies are OK in an environment where they can plan for 28 Morningstar Advisor December/January 2011

Table of Contents for the Digital Edition of Morningstar Advisor - December 2010/January 2011

Morningstar Advisor - December 2010/january 2011
New on
Letter From the Editor
What Strategies Do You Use to Help Retirees Hedge Against Longevity Risk?
Investment Briefs
Four Picks for the Present
Scaring the Swiss
Tech Is the Apple of Managers’ Eyes
How to Read an Sec Filing
A Strategy That Loves Performance Chasers
Things Fall Apart, Even in Industrials
A Future in Questions, Not Answers
Research Over Chocolates
Creating Portfolios That Confront Retirement’s Risks
Building in-Retirement Portfolios to Last
On the Lookout for Guaranteed Income Streams
What Fires Up Mairs & Power
All Aboard!
Aiming at Alternatives
Stuff Your Stocking with Out-of-Favor Bargains
Stable, High Yields (No Bonds Included)
Mutural Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks with Wide Moats
Twelve Bee, Huh?

Morningstar Advisor - December 2010/January 2011