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EE/MI Sector Update
The Sound of Silence
Electrical Equipment & Multi-
Industry
C. Stephen Tusa, Jr CFAAC
(1-212) 622-6623
stephen.tusa@jpmorgan.com
Phil Gresh
(1-212) 622-4861
phil.m.gresh@jpmorgan.com
Drew Pierson
(1-212) 622-6627
drew.a.pierson@jpmorgan.com
J.P. Morgan Securities Inc.
See page 54 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. Customers of J.P. Morgan in the United States can receive independent, third-party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
Our fundamental view continues to call for a deep and protracted downturn. Our
estimates show a 50% decline 2008-2010, with ’10 numbers that are >30% below
Consensus. On the stocks, the noise from the initial credit market gyrations, as
well as from Washington and management has died down, and all we are left with
are expectations for execution on an optimistic scenario (both on stimulus and
guidance). Our level of hope is low. This being said, after the most recent leg
down, we think the group is now in a “no man’s land,” in which the stocks are still
not “no brainers,” but cheap enough for a debate. However, as much as sentiment
is poor, Street estimates remain too high, and therefore we continue to think
patience pays and look for a greater sense of conservatism out of Street
estimates/management as a buying indication. For now, there is no immediate
change to our ratings.
• Management playbook looks optimistic. Despite denial that plans are based
on a 2H economic recovery, with average 1Q EPS guided to down ~40%, a
ramp in 2H is just that, based on “easier comps,” as well as restructuring.
• Easier “comps” = 2H recovery: this is not an inventory correction. The
premise here is that things get better quickly, justified by a re-stocking.
Inventory metrics remain at unfavorable levels as companies continue to chase
demand down. There may be a temporary re-stocking at some stage this year,
but we still have a way to adjust out the structural imbalances built by easy
credit. We expect to enter 2010 with organic declines.
• Restructuring not a silver bullet; price turns negative. On the bottom line,
we continue to believe that a combination of pricing pressure and negative
operating leverage will overwhelm cost saves. Restructuring spend of ~1.5% of
sales this cycle compares to ~3% of sales last cycle in which margins were down
an average 350bps and pricing was not the benefit it has been in recent years.
• 2010 non-fundamentals: goodbye forex (maybe), hello pension. Pension fund
performance from ’08 will hit hard in ’10, with a double whammy from ’09
returns (most affected are HON, IR, TXT).
• Street cuts: right direction, wrong magnitude. We remain Street low on
almost all the stocks. We think 2010 is another down year, as backlogs that are
good for early 2009 push the bulk of weakness into 2H, a run rate which does
not bode well for 2010, where we are >30% below Consensus.
• Valuation: better after most recent leg, but time not on our side. At 12x
’10E EPS, the group is not expensive, but is not a “no brainer” – there is
precedent for high-single-digit multiples (early 1980s). We remain patient.
• Selective rating stance maintained: <25% OW. We have lowered our group
price target to an 11x multiple on 2010E EPS, down from 12x, which implies
~10% downside risk. This is less than our 20% downside from December, but
enough to keep us cautious for now.
Table of Contents
Fundamentals Have Not Improved, But Valuation Has (a
Bit)…..........................................................................................4
Our Ratings: The Answers Lie in the Matrix ........................10
Fundamental Outlook: Corporate Credit Cycle Still
Unwinding; Structural Imbalances Suggest That This Is Not
an Inventory Correction .........................................................13
These Look Like Structural Imbalances ....................................................................17
In Other Words: This Is Not a Temporary Inventory Correction...............................20
Margin Outlooks Appear Optimistic: Restructuring Not a
Silver Bullet.............................................................................25
Non-Fundamentals: Goodbye Forex Headwind (Maybe),
Hello Pension..........................................................................30
Valuation More Reasonable, But Not Without Risk .............39
Valuation and Risks ...............................................................43
3M Corporation (MMM/OW) – Price Target: $44 ....................................................43
Danaher (DHR/OW) – Price Target: $46...................................................................43
Dover (DOV/UW) – Price Target: $21......................................................................43
Emerson Electric (EMR/UW) – Price Target: $22 ....................................................43
General Electric (GE/N) – Price Target: $8...............................................................44
Honeywell (HON/N) – Price Target: $21 ..................................................................44
Ingersoll-Rand (IR/N) – Price Target: $12 ................................................................44
ITT Corporation (ITT/N) – Price Target: $30............................................................45
Rockwell Automation (ROK/N) – Price Target: $14.................................................45
Roper Industries (ROP/OW) – Price Target: $32 ......................................................46
SPX Corporation (SPW/N) – Price Target: $30.........................................................46
Textron (TXT/N) – No Price Target ..........................................................................46
Tyco (TYC/N) – Price Target: $17............................................................................47
WW Grainger (GWW/UW) – Price Target: $43 .......................................................47
Wabco (WBC/N) – Price Target: $9..........................................................................47
Watts Water (WTS/N) – Price Target: $12................................................................48
Wesco (WCC/OW) – Price Target: $16.....................................................................48
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