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It ain't real fancy, it ain't real pretty and it ain't gonna make the cover of too many magazines, but the evidence is undeniable: U.S. factories are back in business not too long after they had been left for dead by skeptics, doomsayers and political opportunists.
As a result, familiar names out of the American heartland like Ford (F, news, msgs), Ingersoll-Rand (IR, news, msgs), Caterpillar (CAT, news, msgs), U.S. Steel (X, news, msgs), Alcoa (AA, news, msgs) and Goodyear Tire & Rubber (GT, news, msgs) are the unlikely first-half heroes of the stock market in 2007, racking up grease-stained gains of 25% to 65%. And after so many years in the wilderness, most are still so cheap that they look like strong prospects to keep on muscling forward during the rest of the year.
Amid the fearful pause on Wall Street precipitated by a few greedy mortgage bankers and hedge fund types this month, you might be excused if you think that stocks are on their last legs.
But that's unlikely to be the case. Leaders this year are not the dot-com clickin', real-estate flippin' yahoos of years gone by. This is a steak-and-potatoes, eat-your-spinach kind of market, in which investors have rolled up their sleeves to research and buy shares of companies focused on the hard-working underbelly of industrial manufacturing.
Cheshire CAT
Despite recent GDP growth numbers that bordered on the zero line in the first quarter, U.S. makers of things have beaten out their flashier services-providing kin to win the hearts of real customers -- not just investors. April, May and June data produced by the U.S. Department of Commerce show factories are experiencing a material rebound in durable-goods orders, capital expenditures, capacity utilization and expansion after several years of drift. GDP growth in the second quarter is going to shock a lot of people as it inches back toward 3%.It's not just domestic demand that's kicking up the numbers. America is making high-quality things that the rest of the world wants -- from motion sensors and conveyer belts to diesel engines, truck tires and jet aircraft -- and we are selling bundles of them. Consider Caterpillar, whose shares are up 31% this year after dozing all of 2006.
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Now in the low $80s, Caterpillar will steam toward $100 over the next year, I think, even if not a single new house is built in the United States. Revenue growth and earnings growth are unlikely to top much more than 7% and 13%, respectively, so the key to a higher valuation for Caterpillar will be an expansion of its price-earnings multiple as investors get increasingly comfortable with its vital role in the long-term build-out of the Asian economy.
This isn't because China is important to Caterpillar as an end market, but because Asia is the main market for most of the companies to which Caterpillar sells. In other words, all the world's energy explorers and producers, miners, electric power generators, heavy construction providers and industrial manufacturers that sell things in or to Asia are the most important customers for Caterpillar today -- not U.S. home builders, as in years past. Almost 60% of the company's total revenue comes from customers for whom China is the principal customer, and India isn't too far behind.
Put another way, strength in global industrialization and urbanization are trumping any softness in U.S. end markets for industrial manufacturers like Caterpillar. I estimate the company will haul in $48 billion in revenue next year and think investors will be willing to pay up to 1.5 times that amount for shares.
Doubts abound
This type of multiple expansion showed up big-time in the 200% recovery in Boeing (BA, news, msgs) shares that have transpired over the past four years. People were skeptical that Boeing would survive its political scandals, management-behavior embarrassments and Sept. 11-related commercial setbacks, but its U.S. engineering and sales teams have proved the skeptics wrong quarter after quarter.Continued: Skeptics miss the global picture
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