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Capital Goods
Mechanicals: Tepid Recovery
in Sight; Atlas Our Top Pick
What's Changed
Industry View: Capital Goods Cautious to In-Line
Upgrading our industry view; raising mechanicals
estimates by 5-10% (ex-Sandvik). While we are still in
a capex down cycle and earnings risks remain, we
upgrade our view of the Capital Goods sector as we see
a more balanced risk-reward. More specifically for
mechanicals, we are increasing our aftermarket
volumes and pricing forecasts in certain segments as
commodity reflation should provide support to oil- and
minerals-exposed areas despite a weak capex
environment. (See “Time for a More Balanced
Approach” published today for more detail on our view of
the overall Capital Goods space).
Commodities reflation drives aftermarket, opex and
pricing power in some segments. Improvement in
leading indicators from 1Q09 lows and 40% rise in
commodity prices will result in higher utilization rates
among mining companies and should benefit mining
equipment companies. Furthermore, our end markets
surveys suggest that pricing outlook has improved for
some segments, such as bearings and mining — hence
separating medium-term winners is key.
Buy early cyclicals, self-help potential and
commodity-linked pricing power. Accordingly, we are
OW Atlas, SKF and Assa. Conversely, we continue to
sell stocks whose earnings have seen the greatest
surge from the capex boom but end markets face
deteriorating pricing and structurally challenged
business models. We are UW Alfa Laval and Metso.
Valuation still unappealing: On our new (and higher)
estimates, valuations still look full with a substantial
recovery being discounted in the price. Mechanicals
sector trades on 11x 2009e P/E. Looking at P/BV and
EV/Sales multiples, we are still close to mid-cycle levels
(0.6x EV/Sales and 1.8x PBV). On average, we estimate
we are c.35% above previous troughs.
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