Wednesday, August 27, 2008

Durable Goods Will Stay Strong

The durable goods sector continues to confound the gloom and doomers. July's growth for the sector was 2%, with year over year growth at nearly 7%. While the sector's string of good numbers seems to surprise investors every time new data are reported, it shouldn't, the major players are all companies that are benefiting from five powerful forces:
  1. They are prime beneficiaries of globalization.
  2. They are net exporters, thus, they have benefited from the fall in the dollar over the last several years.
  3. As a result of many years of consolidation, they are a much more focused industry with far few players than just a few years ago.
  4. They are getting a tail wind from companies in the US who are using these softer economic times to upgrade their operating efficiencies through the purchase of new capital equipment.
  5. These companies are not the old metal bending companies that come to mind when many people first think of the group. The companies, in many cases, have converted themselves into technology companies that bend metal around some sort of a computer application.

Yet, while this group has continued to put up good numbers, many of the best companies in the group have languished, including United Technologies (UTX). Its price is down 11.8% over the last year, even though its earnings have risen in mid-double digits.

Indeed, looking at UTX from an historical perspective is very revealing: Over the last 20 years, UTX's earnings and dividends have grown at about 10% per annum. During this same time, its P/E has averaged about 20x. Based on projected earnings for 2008, with earnings growth projected to be up nearly 12.5%, UTX's P/E is running at about 13.5x earnings. This doesn't make much sense. Earnings growth will be up nearly 25% over UTX's long-term average, yet it's price to earnings multiple will be down nearly 30%. The same kinds of relationships hold for its 10 and 5 year ratios, as well.

UTX, along with many other durable goods companies, have gotten very cheap, and we don't believe the forces that have driven their successful operating results are going away anytime soon. Thus, we believe they are significantly undervalued.

This means we are not in the camp that believes that the dollar is starting a secular upward march, neither do we believe that the forces of globalization are at and end.

Our Dividend Valuation Model above shows that UTX has sunk deep into an undervalued condition. Our model is projecting that 2009's fair value for UTX is near $82. With the stock selling around $65, that leaves room for a nice potential gain in the coming year.

As we say often, our model is not foolproof, but we believe it has done a good job of uncovering relative value over the years. We think UTX is a great company and a good value. We own the stock and have been buying it. If you would like more information on the services Donaldson Capital Management offers, please see our website:

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