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John,
Look's to me that SSB is trying to clarify in order to create more
confusion.
The new rating system is based on their estimation of a stock's relative
strength to the S&P 500. In a bear market, if the S&P 500 loses 50% and if
SSB's best stocks only lose 40%, they can delcare themselves genuises, while
the customers go broke. I guess that's why they call them brokers. They help
the clients to get broker. This is just more Wall Street BS and by BS I
don't mean Bear Stearns. Is there any one group of people on the face of
the earth that are more over paid than stock analysts?
Cheers,
Norman
----- Original Message -----
From: "John Cappello" <jvc689@xxxxxxx>
To: <realtraders@xxxxxxxxxxxxxxx>
Cc: <MedianLine@xxxxxxxxxxxxxxx>
Sent: Sunday, September 08, 2002 9:39 AM
Subject: [RT] Fwd: ~ Salomon Smith Barney/ GE/ PEs
> Below is a report revolving around GE [in context with a Median Line
> post] as well as their PE analysis and state of the economy. Hope it
> is of interest. As the saying goes "As goes GE so goes the S&P"
>
> John
>
>
> S a l o m o n S m i t h B a r n e y R e s e a r c h
> Introducing Our New Rating System
>
> General Electric Co(GE)
> Rating: 1L
> As of 09/08/2002
> Last Changed 09/07/1999
>
>
> The Salomon Smith Barney Equity Research Department
> changed their Stock and Industry Ratings System as of September 7,
> 2002. Click here for more information.
> Salomon Smith Barney ~ September 7, 2002
>
> See last pages for Important Disclosures
>
> Multi-industry
> Introducing Our New Rating System
>
> September 6, 2002 SUMMARY
> * We are introducing a new "relative" ratings
> system for
> Jeffrey T. our coverage list in accordance w/ SSB's new
> research
> Sprague, CFA guidelines which requires our universe of stocks
> to be
> ranked in preference relative to each other.
> For the
> purposes of this note our entire coverage list
> is being
> John Roselli, CFA considered "multi-industry".
> * We believe our industry will outperform the S&P
> 500
> over the coming year. We would Overweight the
> Mark Wilterding multi-industry group because the group typically
> outperforms in the earlier stages of an economic
> cycle
> and valuations in general are below historical
> averages.
> * Although the nomenclature is changed, our view
> on our
> industry and stocks is essentially unchanged.
> Our
> Outperform-rated stocks in order of preference
> are Tyco,
> SPX Corp, GE, and Danaher.
> OPINION
> We rate our Multi-Industry group overweight versus the S&P 500. Our
> group
> typically out performs the S&P 500 in the early portion of economic
> recoveries. For example, in the 1991-1993 time frame our group
> appreciated
> 76% compared to a rise of 41% for the S&P 500. Often in the early
> stages of
> recoveries the fundamentals actually still look quite grim and
> earnings can
> remain disappointing. We appear to be in that type of environment
> currently.
> However, the "promise" of recovery, which often manifests itself in
> small and
> uneven hints of impending improvement, can drive the stocks. When a
> robust
> recovery is actually underway the group's relative performance tends
> to
> moderate. Valuations also support our overweight position. Our
> group on
> average is trading at ~15X forward earnings compared to a historical
> average
> forward P/E of ~17X. We believe valuations have room to expand as
> nascent
> signs of economic improvement emerge over the next 6-12 months.
> The SSB strategy team forecasts approximately 19% total return
> potential in
> the S&P 500 to December 2003. We do not know if that forecast will
> prove
> accurate but, we believe our group can outperform the S&P 500 over
> that
> period of time. Our coverage universe has gone through massive
> restructuring
> the past 2 years that provides significant earnings leverage even if
> revenues
> up tick only slightly. Although the earnings outlook remains
> difficult the
> majority of our companies have stopped missing estimates and downward
> earnings revisions have moderated significantly. Earnings and order
> comparisons are easy from Q3 onward. Additionally, most companies on
> our
> list have healthy balance sheets and good cash flow providing the
> opportunity
> to augment growth with acquisitions or share repurchase.
> For the purposes of this note and the ratings of our stocks our entire
> coverage list is being named Multi-Industry including stocks such as
> GE,
> Emerson and Hubbell, which have been traditionally described
> as "Electrical
> Equipment". At some later date within the SSB system the group will
> be
> renamed Electrical Equipment & Multi-Industry to provide a more
> precise
> description. However, this impending change is a housekeeping item
> and in
> isolation signals no future change in the ratings and thesis provided
> in this
> note.
> The new SSB rating system requires that stocks in an analysts
> coverage list
> be rated relative to each other under the 3 ratings
> of "outperform", "in-
> line" and "underperform", replacing the previous 5 tiered rating
> system.
> Given this type of format our ratings will have a generally even
> dispersion
> across the three ratings categories. Although the ratings
> nomenclature has
> changed, our view on our industry and the individual stocks is
> essentially
> unchanged. However, we can envision more frequent ratings changes
> under this
> new system since big price moves up or down by individual stocks will
> require
> a more overt re-evaluation of their relative standing in the group.
> Additionally, our ratings will have a more clinical nature.
> The "best"
> companies in the group are more likely to be rated In-line or
> Underperform
> from time to time based on their relative valuations while weaker
> companies
> will be more likely to be rated outperform if they get excessively
> cheap.
> Our initial application of the new ratings results in a dispersion of
> 4
> "outperforms", 7 "in-lines" and 4 "underperforms".
> Our Outperform-rated stocks in order of preference are Tyco, SPX
> Corp, GE and
> Danaher. Tyco, GE and SPX were all rated "buy", while Danaher was
> rated
> "outperform" under the previous rating system. We've long maintained
> that
> "story" stocks tend to be the best performers in our group and most
> of our
> outperforms fit this criteria. Tyco is undergoing a cleansing by a
> new CEO
> following the resignation of the former CEO. We believe
> this "healing"
> process will drive the valuation higher as investors refocus on the
> value of
> the business franchises. SPX remains on a path to emerge as a premier
> company in the group and improving cash flow supports valuation
> expansion.
> Danaher continues to distinguish itself with excellent execution
> during the
> current industrial downturn. While not cheap, its strong balance
> sheet gives
> it the dry powder to augment growth with acquisitions. GE is
> somewhat of a
> special case. The stock has been crushed over the past 2 years given
> concerns about numerous issues such as succession and the outlook for
> Power.
> However, the fact remains that GE is a premier global company with
> returns on
> capital essentially double our group average. As we roll into 2003,
> we
> believe the market will begin to anticipate acceleration in earnings
> growth
> in 2004 as the headwinds from Power and Aerospace moderate and short
> cycle
> growth and acquisitions play a larger role.
> Our "in-line" rated stocks are ITT Corp, Honeywell, American Standard,
> Emerson, Maytag, Cooper and Whirlpool. Since we are carrying
> an "overweight"
> on our group we believe all of these stocks are candidates to
> outperform the
> market. Previously ITT, Honeywell Maytag and American Standard were
> rated
> "outperform" while Emerson, Cooper and Whirlpool were rated neutral.
> We
> remain very positive on the outlook and internal improvements
> underway at
> ITT. However, the stock has strongly outperformed everything in our
> group
> this year and is now at a premium valuation. A price pullback would
> be cause
> to re-evaluate our rating. American Standard continues to impress us
> with
> good internal execution and above average organic growth. Honeywell
> faces
> near term pressures due to the dismal outlook for commercial aviation
> and
> weak industrial capital spending, but has significant leverage to
> eventual
> recovery and is reasonably valued. On Emerson, earnings visibility
> is still
> limited, but we believe estimates have hit bottom and comparisons are
> beginning to get easy. Additionally, Emerson's orders have turned
> positive
> (largely easy comps) after 15 months of declines. Maytag is a
> consumer play
> and we favor it because we believe margins have significant upside
> even if
> industry appliance shipments do not rise from current levels. Cooper
> and
> Whirlpool are in this new "in-line" group because their very low
> valuations
> limit downside, but our fundamental cautious view on both companies is
> unchanged.
> Our "underperform" rated stocks are Hubbell, Rockwell, ITW and
> Textron and
> all were rated "neutral" under the previous rating system. These are
> some of
> the most expensive stocks in our universe (TXT looks cheap on P/E, but
> expensive on cash flow, by our analysis) all have outperformed our
> group (and
> the S&P 500) year to date suggesting that relative upside versus the
> remainder of the group is limited. However, given our view that the
> group
> will have an upside bias over the next twelve months, these stocks
> could
> trade higher in absolute terms. Additionally, all of our
> underperforms
> except ITW have dividend yields above the S&P average suggesting good
> downside protection.
> Rating Price
> Target
> Company (Price) Symbol New System Old System
> New Old
> MULTI-INDUSTRY
> Danaher ($60.15) DHR 1M -- Outperform 2M -- Outperform
> $74 $74
> General Electric ($30.15) GE 1L -- Outperform 1L -- Buy
> $38 $38
> SPX Corporation ($108.60) SPW 1M -- Outperform 1M -- Buy
> $140 $140
> Tyco International ($15.69) TYC 1S -- Outperform 1S -- Buy
> $22 $22
> American Standard ($71.63) ASD 2H -- In-Line 2H -- Outperform
> $80 $80
> Cooper Industries ($32.72) CBE 2M -- In-Line 3M -- Neutral
> $35 $35
> Emerson ($48.78) EMR 2M -- In-Line 3M -- Neutral
> $54 $50
> Honeywell ($29.95) HON 2H -- In-Line 2H -- Outperform
> $36 $42
> ITT Industries ($67.98) ITT 2M -- In-Line 2M -- Outperform
> $74 $74
> Maytag ($32.64) MYG 2H -- In-Line 2H -- Outperform
> $42 $52
> Whirlpool ($55.31) WHR 2H -- In-Line 3H -- Neutral
> $65 $68
> Hubbell Incorporated HUBB 3M -- 3M -- Neutral
> $35 $35
> ($32.10) Underperform
> Illinois Tool Works ($68.52) ITW 3M -- 3M -- Neutral
> $68 $68
> Underperform
> Rockwell Automation ($18.42) ROK 3M -- 3M -- Neutral
> $20 $20
> Underperform
> Textron ($38.85) TXT 3H -- 3H -- Neutral
> $45 $50
> Underperform
> Note: Prices are as of market close on August 30, 2002
> VALUATION AND RISKS
> Danaher (DHR--$60.15; 1M)
> Valuation
> Danaher's stock is not cheap, trading at nearly 19X our 2003 estimate
> versus
> a group average of 14X. However, the company has perennially been a
> top cash
> flow generator which supports a premium P/E valuation. On a
> price/free cash
> flow basis the stock is at a modest 10% premium to our group.
> Management's
> ability to take out costs, drive margin improvement, and deliver
> strong cash
> flow despite severe pressure on core revenues enforces our confidence
> in the
> company. Similar to other companies in our universe, DHR has seen
> hints of
> an economic bottom, but does not anticipate an meaningful cyclical
> recovery
> until late '02 at the earliest. Acquisitions consummated earlier in
> the year
> and restructuring savings should support earnings even if the top line
> remains sluggish. Our price target of $74 equates to the 5 year
> average P/E
> of ~23 applied to our $3.20 estimate for 2003.
> Risks
> Potential risks include the ability to integrate recent acquisitions
> into the
> portfolio. Since the beginning of the year, DHR has closed three
> sizeable
> deals that will add a combined total of ~$900 million in annualized
> revenues.
> Sluggish industrial capital spending levels and depressed utilization
> rates
> could also pressure many of the company's general industrial
> businesses.
> Within DHR's Motion Control segment, continued weakness in key end
> markets
> such as semiconductors, electronic assembly, and telecom, which
> collectively
> account for ~25% of segment revenues, may pose a risk to estimates.
> Furthermore, declines in consumer spending may adversely impact
> certain hand
> tool businesses including Delta and Craftsman. A prolonged downturn
> in
> Danaher's relatively volatile Power Quality businesses may also
> result in
> downward earnings pressure.
> General Electric (GE--$30.15; 1L)
> Valuation
> Our 2003 estimate of $1.78 equates to about 8% EPS growth, which is
> below
> GE's stated goal of "double digits". We are not ruling out hitting
> 10%+ EPS
> growth in 2003 but we do not have the visibility to maintain our
> forecast at
> that level. If the economy rebounds strongly in 2003 and GE's
> acquisition
> program remains successful our estimates have upside. Furthermore, we
> believe GE can post accelerating earnings growth in 2004, assuming we
> are
> well into a recovering economy at that point and other businesses (and
> acquisitions) are better able to offset the long cycle headwind at
> Power and
> Aircraft. Although 2004 is a long way off, the market has been
> fretting
> about GE's '03 earnings outlook since at least the middle of 2001.
> As we
> approach year-end and roll into 2003 the debate will begin to shift
> away from
> 2003 to 2004. Power and Aircraft will still face pressures in 2004,
> but
> their relative drag should diminish and as mentioned above other
> pieces of
> the portfolio should be on a better stride.
> Our $38 target assumes a 21X P/E on our '03 estimate, or about a 25%
> premium
> to the market multiple. The stock may remain stuck in a trading
> range until
> more short cycle visibility emerges, but we believe the stock can
> outperform
> the market over the next 12 months. We believe that GE deserves to
> trade at
> a premium to the market multiple given the company's extraordinary
> ROIC,
> solid balance sheet, leading businesses and above average growth
> potential.
> Furthermore, in an age of corporate governance concerns and management
> credibility issues, GE appears well suited to defend any criticism
> that may
> arise.
> Risks
> GE is one of the world's largest companies and as a result has
> exposure to
> numerous global economic and political risks. Primary specific risks
> in the
> near term include the potential for a further fall-off in the Power
> business
> due to the distressed nature of GE's customers. GE is also exposed
> to the
> troubled airline industry through its engine and leasing businesses.
> We
> believe it has managed its airline risks well, but the potential for
> further
> industry deterioration remains a risk. Finally, continued
> improvement in
> short cycle businesses, especially Plastics, is key to offsetting
> declining
> earnings in Power Systems.
> SPX Corporation (SPW--$108.60; 1M)
> Valuation
> SPX remains one of our top picks. The company has consistently hit
> earnings
> expectations and appears solidly on track in 2002. Free cash flow
> should be
> strong again in 2002 at ~$350mm or approximately 95% of net income
> (over 100%
> on a pre-FAS142 basis). Even if we assume $1.00 of EPS dilution due
> to LYONs
> conversion with no offsetting cost reductions, the stock looks cheap
> at ~11X
> our '03 forecast. The company continues to execute well in a
> difficult
> environment and we believe the stock remains undervalued. Our $140
> target
> assumes that the stock trades at a slight discount to the average P/E
> multiple for our group of 14-15X our 2003 estimates. Historically,
> the stock
> has traded at a discount to our group, but it is difficult to rely on
> history
> given the substantial change the company has undergone over the past
> 5 year.
> In 2001, SPW was one of the top organic growers and top cash
> generators in
> our coverage list and we believe it will rank similarly in 2002. We
> believe
> this continued group beating performance warrants a multiple in line
> with our
> group and positions the company to possibly obtain a premium
> valuation over
> time.
> Risks
> One potential risk to SPX stock is the potential dilution from its
> equity-
> linked notes (LYONs), which were issued in February and May of 2001
> for a
> combined face value of $1.41 billion. If/when the LYONs are
> triggered, the
> potential converted shares must be added to SPX's diluted share
> count. We
> estimate that adding these shares, if included for the full year,
> would
> result in dilution of ~$1.00 to our 2003 estimate. However, we
> believe SPX
> will be able to largely offset this dilution through additional cost
> savings
> from UDI, bolt-on deals such as Balcke, and upside leverage in an
> improving
> economy. We believe another possible investment risk to SPX concerns
> the
> impending slow-down at the company's power transformer business,
> Waukesha
> Electric. Going forward, we expect this business, which is the
> largest in
> the Industrial Products segment, to continue rolling over and
> experience
> significant revenue declines in 2H02 and 2003, reflecting the sharp
> downturn
> in the power industry following several years of prosperity. Sluggish
> industrial capital spending levels and depressed utilization rates
> could also
> pressure many of the company's general industrial businesses. It
> should also
> be noted that SPX is thinly traded with a small float relative to
> other names
> in our universe. As a result, the stock has demonstrated very high
> volatility. SPX also maintains the highest short interest in our
> group with
> roughly 8% of the float in the hands of shorts.
> Tyco International (TYC--$15.69; 1S)
> Valuation
> We are encouraged by the speed at which new CEO Ed Breen is moving to
> restore
> credibility. In addition to the two internal investigations, Mr.
> Breen has
> moved to change CFOs, added a new independent board member and
> created a new
> executive corporate governance position. Our price target remains
> $22, which
> represents a sum-of-the parts valuation using the lowest valued peer
> for each
> segment. We believe a revenue-based valuation is the most
> conservative
> approach since revenues are more black and white than GAAP earnings.
> Our
> target implies a P/E multiple of ~10X our FY03 estimate, or a 30%
> discount to
> our coverage group average.
> Risks
> Tyco shares are only for investors with the highest risk tolerance.
> Tyco has
> gone through tremendous turmoil in 2002 culminating in the
> resignation of its
> former CEO. However, with a well-respected new CEO hired and CIT
> disposed
> the risks are reduced. We still have concerns that damaging
> revelations
> could be revealed during the course of internal and external
> investigations.
> We cannot rule out some type of earnings restatement or negative
> corporate
> governance revelations. Tyco shares are likely to remain very
> volatile with
> high "headline risk." We will be closely scrutinizing Mr. Breen's
> actions
> and considering any corporate revelations constantly. It remains
> possible
> that something so damaging could be revealed that will cause us to
> reconsider
> our rating. Additional risks could arise from sluggish industrial
> capital
> spending levels and depressed utilization rates. Tyco's exposure to
> the
> volatile connector market is also a potential risk. Although year-
> over-year
> sales declines have moderated in recent months and book/bill trends
> have
> improved, the connector industry is not out of the woods yet. A
> subsequent
> downturn in industry sales coupled with intensified competition could
> result
> in an earnings shortfall at Tyco.
> American Standard (ASD--$71.63; 2H)
> Valuation
> We believe continued operational improvements and deleveraging at
> American
> Standard can drive the stock price and valuation higher over time.
> However,
> the valuation is no longer compelling in our view following the
> significant
> upward revaluation the company has enjoyed over the past couple
> years. We
> value ASD relative to our group and on a sum-of-the parts basis. We
> do our
> sum-of-the-parts work using 3 approaches: Total Enterprise Value
> (TEV)/Sales,
> TEV/EBITDA and P/E. We favor the TEV approaches because they fully
> capture
> the comparative capital structures of the peers. The stock is
> trading near
> all-time highs versus our group at about a 10-12% P/E discount. We
> believe
> the stock can ultimately move to parity or even a slight premium as it
> deleverages given its strong organic growth profile. Our 12-18 month
> price
> target of $80 is based on our coverage universe average TEV/EBITDA
> multiple
> of ~8.0X applied to our '03 EBITDA estimate for American Standard.
> Risks
> Investors in American Standard shares should consider numerous
> potential
> risks. The company has benefited from the surprising resilience in
> new and
> existing home sales which has been a strong driver of residential air
> conditioning and plumbing products. About 65%-75% of activity in
> these
> markets is driven by remodeling activity. We believe the company can
> continue gaining share, which would mute a downturn in residential
> markets,
> but the company would still be impacted. Commercial construction
> markets
> also remain a risk. There are also numerous environmental and
> regulatory
> requirements such as the use of particular refrigerants or minimum
> efficiency
> requirements that constantly impact the air conditioning market. ASD
> also
> has significant overseas exposure, which remains a risk given the
> uncertain
> pace of economic recovery. The company is also highly leveraged on an
> historical book basis although its coverage ratios and liquidity
> appear more
> than adequate. Nevertheless, in a severe downturn, cash flow could be
> negatively impacted and the company could find it difficult or
> expensive to
> refinance maturing debt obligations. Asbestos also poses a risk to
> the
> company, although we believe the company's exposure is relatively
> minor. The
> company has never paid a claim out of its own pocket to date and
> claims it
> holds ample insurance coverage.
> Cooper Industries (CBE--$32.72; 2M)
> Valuation
> Our price target of $35 equates to ~10X our 2003 EPS estimate, which
> is at a
> significant discount to the company's average forward multiple of 13X
> over
> the last five years and represents modest improvement over current
> levels.
> We have taken into account lower peer valuations, recently lowered
> guidance,
> and management's expectations of no material recovery in its served
> end
> markets in 2002. With the reincorporation in Bermuda behind it, the
> company
> may be in a position to leverage its lower tax rate, and subsequently
> greater
> cash flow, to become more effective in the markets in which it
> competes.
> Risks
> The primary risk to CBE's near term performance is continued weakness
> across
> end markets through H202 and possibly beyond. While it appears
> declining
> demand trends have in general bottomed, continued weak demand in
> commercial
> and industrial construction, as well as tool dependent industries,
> into H202
> could signal a slower and/or delayed recovery. The company also has
> exposure
> to asbestos litigation. The trend in settlement activity has been
> encouraging but it is impossible to forecast future developments.
> Finally,
> there is the possibility that anti-repatriation bills in the House
> and Senate
> gain traction and put CBE's recent headquarters' move to Bermuda in
> jeopardy.
> Emerson (EMR--$48.78; 2M)
> Valuation
> The stock is not cheap at 19X and 17X our FY2002 and FY2003 estimates,
> respectively. However, we are bumping our price target to $54 from
> $50 which
> equates to ~18X our calendarized 2003 estimate which is in line with
> the 10
> year average P/E. Our previous target of $50 was derived from the 15
> year
> average P/E of ~17X. With comparisons becoming easier and orders
> turning
> positive, we believe a slightly less conservative target is
> warranted. We
> believe Emerson is on the right track internally with its
> restructuring
> program and its drive to lower the capital intensity of the
> portfolio. These
> actions should lead to a faster growing and more profitable company
> over the
> next several years.
> Risks
> While it appears that EMR's Electronics business has stabilized, there
> remains only early indications that underlying demand has improved.
> The
> business has at least one more quarter of difficult comps before
> lapping last
> year's declines. A prolonged downturn in the company's Electronic
> businesses
> (which account for roughly 20% of consolidated sales) may result in
> downward
> earnings pressure. It should also be noted that EMR's industrial
> businesses
> (Process Control, Industrial Automation) are closely tied to capital
> spending
> levels and utilization rates. Continued weakness stemming from
> either metric
> could pressure results going forward. In addition, a slow-down in
> new and
> existing home sales could lead to a decline in residential HVAC sales.
> Despite the potential risk to earnings, we believe EMR is on the
> right track
> internally with its restructuring program and its drive to lower the
> capital
> intensity of the portfolio. These actions should lead to a faster
> growing
> and more profitable company over the next several years. It should be
> acknowledged that uncertainty associated with the plan could pose a
> risk to
> the stock. Management's savings run rate expectations are dependent
> upon
> successful execution. Delays and/or difficulties in implementation of
> restructuring efforts could negatively impact results.
> Honeywell (HON--$29.95; 2H)
> Valuation
> Trading at less than 12X our 2003 estimate, we believe downside risk
> is
> limited. Airline industry weakness is well understood by investors
> and
> largely incorporated into HON's stock price, in our opinion. The
> stock is
> currently trading a 19% discount to our coverage group and 30%
> discount to
> the S&P 500 based on '03 EPS estimates. While headline risk may keep
> a lid
> on the stock in the near-term, we view it as an attractive investment
> for
> patient investors with a 12-month time horizon. We reiterate our 2H
> rating.
> We are trimming our price target to $36 from $40 to reflect HON's 15-
> year
> average forward P/E of ~14X applied to our 2003 estimate of $2.55.
> Our prior
> target applied HON's higher 10 year average P/E to our estimates, but
> in
> light of very tough aerospace fundamentals, we believe a more
> conservative
> target is warranted.
> Risks
> Investors in Honeywell should consider several risks. First, we
> remain
> concerned that the current commercial aerospace downturn will linger
> well
> into 2003 with the depth and duration of the downturn still in
> question.
> Honeywell's relative upside could be restrained by its commercial
> aerospace
> business, which represents roughly 25% of total HON revenues and a
> higher
> portion of profits. In addition, while management expects that
> restructuring
> charges are now behind the company, we can't ignore the potential
> valuation
> impact of over $4.0 billion in cumulative below-the-line restructuring
> charges taken over the past three years. HON also has asbestos
> exposure that
> we believe is widely known by the market. However, an adverse ruling
> against
> HON or another company could cause stock price weakness. HON seems
> to have
> strong insurance protection, but we cannot forecast the velocity of
> new cases
> or the future size of settlements or judgments.
> ITT Industries (ITT--$67.98; 2M)
> Valuation
> ITT continues to impress us with its consistent performance and
> improving
> fundamentals. As we look ahead to the rest of 2002 and into 2003, we
> believe
> the company could be facing an extended period of prosperity. The
> company is
> currently trading at roughly 17X our 2003 estimate of $4.05, which
> equates to
> a 15% premium to our group average. Our price target of $74 reflects
> the
> high end of our sum of the parts valuation range on a TEV/Sales and
> TEV/EBITDA basis, which suggests a value between $71-74. Our 2M
> rating
> reflects ITT's expanded valuation versus its peers, which could limit
> relative upside from current levels. The stock has been the strongest
> performer in our coverage list year to date by a wide margin.
> Risks
> Key risks to our investment thesis on ITT are primarily economic.
> While 60%
> of ITT revenues come from recession-resistant industries such as
> defense and
> water/wastewater, the remaining 40% are cyclical and subject to
> swings in
> revenue and profitability. Cyclical businesses include ITT's
> Electronic
> Components business, the Motion & Flow Control Platform and about a
> third of
> the Fluid Technology market. Further weakness in any of these markets
> relative to expectations could result in downward estimate
> revisions. As the
> defense industry enters a new phase of growth, ITT's core strengths
> (communications, electronic warfare, engineering) are positioned at
> the
> forefront of the Depart of Defense's procurement plans.
> Nevertheless, the
> loss of a key defense contract to a competitor could result in
> downward
> pressure on the stock.
> Maytag (MYG--$32.64; 2H)
> Valuation
> We continue to view the company as a turn-around and margin expansion
> story
> given the opportunity to restore profitability in its core business
> and
> further margin upside at Amana. MYG is currently trading at 11X and
> 10X our
> 2002 and 2003 EPS estimates, respectively. This is toward the low
> end of the
> company's historical trading range. Truncating historical valuation
> extremes, the stock has generally traded in a range of 10-20 times
> forward
> earnings over the past 15 years. The average forward valuation over
> this
> time frame is about 15X EPS. However, we believe a 20% discount
> applied to
> this mean is justified in order to take into account the uncertainty
> that the
> pace of consumer spending and growth in residential housing markets
> will be
> able to continue at current levels. We therefore believe our target
> should
> be based on a more conservative 12X multiple, resulting in our price
> target
> dropping to $42 from $52.
> At these levels, we believe the stock could be considered cheaply
> valued if
> strong consumer demand continues, residential housing remains
> resilient, and
> the company maintains a steady stream of innovative and value-added
> new
> product introductions. Longer term, continued strong internal
> execution and
> improvements in profitability could justify the stock moving closer
> to the
> mid point of its historical forward multiple range.
> Risks
> Although appliance shipments in the categories that the company
> competes, the
> so-called "Core 6", have been remarkably resilient, MYG is almost
> entirely
> dependent upon U.S. appliance demand. The possibility of Fed Funds
> rates
> rising next year could have a significant cooling effect on the
> domestic
> housing market. Slower than expected economic recovery could also
> have a
> negative effect on consumer demand. Competition based risk comes
> primarily
> from WHR as the company nears the end of a significant restructuring
> program.
> This is expected to result in more efficient internal operations and
> therefore presumably more room to price product competitively, and
> acceleration in feature laden premium product introductions targeted
> at the
> high-end consumer, which is MYG's primary stomping grounds. Our
> earnings
> forecast is also dependent on deriving further cost synergies from
> the 2001
> acquisition of Amana.
> Whirlpool (WHR--$55.31; 2H)
> Valuation
> WHR appears fairly, or even cheaply, valued at 9X and 8X our 2002 and
> 2003
> EPS estimates at present. Excluding historical outliers, the stock
> has
> traded between 8X-16X forward earnings over the last 20 years with an
> overall
> mean of 12.7X. We are encouraged by modest improvement in Europe,
> but are
> still concerned about economic instability in Latin America. There
> are also
> the issues of tougher comps going forward, the possibility of raw
> material
> pressures that could begin to have some impact in 2003, and the
> potential of
> rising Fed funds, although the near term possibility has diminished
> considerably as of late.
> We are lowering our price target to $65 from $68, which equates to
> 9.6X our
> '03 EPS estimate. This is at the lower end of its 5-year forward P/E
> range
> and represents a ~25% discount to the stock's historical mean of
> ~13X, which
> takes into account concerns about earnings quality, weak cash flow and
> exposure to troubled Latin America. However, the stock could be
> considered
> cheaply valued if strong consumer demand continues, residential
> housing
> remains resilient, and the company continues to introduce a steady
> stream of
> innovative and value-added new products. Our previous target of $68
> assumed
> the multiple could expand closer to the mid point of its historical
> range
> with the prospect of a stronger economy. We believe that assumption
> is now
> too optimistic given the macro-backdrop.
> Risks
> Although domestic appliance shipments have been surprisingly
> resilient for
> almost a year now, WHR derives over 30% of its revenues from
> overseas. A
> fragile European recovery and tenuous political climate and currency
> devaluations in Latin America continue to cast a cloud of uncertainty
> over
> international contributions. Domestically, primary risk revolves
> around
> economic recovery and concerns of slipping consumer confidence.
> Competition
> based risk comes predominantly from MYG as the company continues to
> make
> progress with its turnaround efforts and refocuses on turning out
> high value
> added appliances. GE has also intensified its competitive efforts in
> the
> Appliance sector. Having solved its U.S. based refrigeration
> production
> issues, Electrolux could be in a position to threaten existing
> refrigeration
> product markets shares.
> Hubbell Incorporated (HUBB--$32.10; 3M)
> Valuation
> We are encouraged by HUBB's restructuring efforts but we remain
> cautious on
> the fundamental outlook given little evidence at present of any
> noticeable
> recovery in Hubbell's end markets. Our 12-month price target of $35,
> could
> be considered rich, but in our opinion is justified for a number of
> reasons.
> Our target represents a multiple of 17.5X our FY03 estimate and is
> barely
> above its 10-year average forward historical multiple of 17.1X. We
> believe
> the valuation is justified given the prospect for accelerated revenue
> and EPS
> growth driven by the current acquisition program. Furthermore, the
> restructuring plan announced in Q401 appears to be on track and should
> eventually lead to a more profitable company.
> Risks
> HUBB's stated desire to grow revenues to $3-$5 billion by 2007 opens
> the
> company to acquisition related risks that have been less of an issue
> in the
> past. While management has stated that the Hawke International and
> LCA Group
> acquisitions are immediately accretive, there always exists
> integration and
> synergy risk. Future acquisitions of the size needed to reach the
> company's
> top line goal expose HUBB to further similar risk. As with any
> restructuring
> plan, there is also uncertainty associated with the plan the company
> announced in Q401. Management's savings run rate expectations are
> dependent
> upon successful execution. Delays and/or difficulties in
> implementation of
> restructuring efforts could negatively impact results. Sluggish
> industrial
> capital spending levels and depressed utilization rates could also
> pressure
> many of the company's general industrial businesses.
> Illinois Tool Works (ITW--$68.52; 3M)
> Valuation
> While orders have recently improved in several of ITW's businesses, a
> sustainable recovery is still uncertain. At 22X and 20X our '02
> and '03
> estimates, we believe the stock is fully valued. Our price target
> of $68
> reflects a 19X-20X multiple on our 2003 EPS estimate and is the
> average
> forward multiple over the last ten years. Although this average
> jumps to 22X
> if we look at the last five years, we believe there is still
> sufficient
> uncertainty to warrant caution and a more conservative valuation. We
> will
> continue to watch for signs of recovery in ITW's key commercial
> construction
> and capital goods markets that could signal the increasing volume
> necessary
> for us to become more bullish on the stock.
> Risks
> Despite being composed of over 600 individual operating identities,
> ITW is
> heavily dependent upon the construction and automotive markets.
> Although
> weak commercial and industrial construction has been partially offset
> by a
> stronger residential market and healthy automotive sales, a rise in
> interest
> rates could cool strong demand putting further pressure on ITW's
> Engineered
> Products -- North America business. Additionally, demand in its
> capital
> goods related end markets appears to be firming but is still very
> weak.
> Finally, ITW's growth through acquisition blueprint leaves the
> company open
> to risks associated with integration difficulties and lower than
> expected
> cost savings and/or synergies.
> Rockwell Automation (ROK--$18.42; 3M)
> Valuation
> Rockwell stock has had a strong run relative to the S&P year to date
> (up ~4%
> vs S&P down ~22%), reflecting the company's position as a leveraged
> upside
> play on an economic recovery. However, given the lack of earnings
> visibility, especially abroad, and a relatively full valuation (~20X
> our
> calendar '02 estimate), we prefer to remain on the sidelines. At
> 15X, the
> stock looks reasonably valued on our '03 estimate, but at this
> juncture there
> is very little visibility to improvement in '03. Our $20 target
> assumes a
> ~17X P/E on our '03 estimate or roughly in-line with the S&P 500
> multiple.
> Risks
> Until a sustained recovery in industrial capital spending and capacity
> utilization rates returns, we believe ROK's earnings could remain
> below
> historical levels. Although we are encouraged by recent trends
> signaling a
> sequential increase in demand at certain end markets, we remain
> hesitant
> until further clarity emerges. While it appears declining demand
> trends have
> generally bottomed, continued weak demand in automotive and consumer
> products
> in 2H02 could signal a slower and/or delayed recovery. The company
> currently
> derives 55% of consolidated sales from consumer and automotive
> related end
> markets. Economic conditions abroad could also pose a risk to future
> earnings in the form of foreign currency exposure.
> Textron (TXT--$38.85; 3H)
> Valuation
> Textron's massive restructuring effort and integration of Six Sigma
> initiatives appear to be gaining traction, but it is too early to
> declare
> victory. With the company's operations at such depressed levels, the
> potential for upside is tremendous. However, the company has
> struggled with
> execution in the past and fundamentals in the company's industrial
> businesses
> are very difficult. Additionally, weakness in the business jet
> market could
> limit upside leverage to a recovery, whether it occurs in late 2002 or
> sometime in 2003. Nevertheless, we are encouraged by Cessna's share
> gains in
> such a competitive environment and will be watching orders closely.
> While
> downside may be limited with the stock at less than 11X our '03
> estimate,
> execution risk, sub-par cash flow and Cessna uncertainty keeps us on
> the
> sidelines. We reiterate our 3H rating and $45 price target. At $45,
> the
> stock would be trading at the low end of its historical forward
> valuation
> average (~12X) but at a premium relative to price/free cash flow (24X
> versus
> group average of ~18X).
> Risks
> Textron has considerable exposure to the business jet sector through
> its
> Cessna subsidiary, which accounts for ~ 30% of total Textron revenues
> and
> ~40% of operating profit. The health of the business jet market
> remains
> uncertain, following the economic downturn and tragedy of 9/11.
> Orders have
> been depressed for over a year, but the company still has more than a
> year of
> production left in its backlog, assuming no further cancellations.
> Another
> risk is the industrial economy. Low capacity utilization, tight
> capital
> spending budgets and continued global weakness could continue to
> pressure our
> estimates beyond our current assumptions. Finally, Textron's massive
> restructuring effort carries execution risk. The restructuring and
> integration of Six Sigma initiatives appear to gaining traction, but
> it is
> too early to declare victory. The company has struggled with the
> execution
> in the past and it is hard to overlook the company's serial
> restructuring
> charges and several disappointing or ill-timed acquisitions although
> we
> believe the company has strengthened its acquisition discipline plan.
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