Surveying Our Analysts for Their Favorite Stocks
We've gathered a list of all-stars from the industrials sector.
As editor of Morningstar GrowthInvestor and manager of the Growth Portfolio, I rely on Morningstar's equity analysts to bring their best ideas to my attention. Morningstar's 1,900-stock coverage universe is divided into industry groups. I recently asked our industrials analysts, who are responsible for sectors ranging from airlines to defense contractors, one question: What company on your coverage list would you most like to own if it was available at the right price? (Of course, Morningstar analysts are prohibited from owning an interest in the stocks they cover, so this question is purely hypothetical.)
Mine would have to be Grupo Aeroportuario del Pacifico (PAC). It's one of three publicly traded Mexican-airport operators (and has a wide moat like the others), but is the only one with an average risk rating (versus above-average ratings for the others). Much like Grupo Aeroportuario Del Sureste (ASR) and Grupo Aeroportuario Centro Norte (OMAB), Pacifico operates its airports in local monopolies and is free to manage its unregulated commercial revenue. Pacifico operates six of Mexico's 10 busiest airports, and its domestic/international passenger levels are more evenly split (61% domestic, 39% international) than those of either ASR or OMAB. As a result, both the influx of low-cost carriers and the U.S.-Mexico bilateral flying agreement strongly benefit Pacifico.
General Dynamics (GD) gets more out of its people and its assets than any other defense contractor. It was the first to break the mold of "large government contractor = pseudo-governmental agency" in which inefficiencies are gross and employees punch out precisely at 5 o'clock, and it has maintained a sizable lead in its ability to generate economic profits. In fact, we only recently awarded our second wide moat to a defense contractor, Lockheed Martin (LMT). And while Lockheed is generating enormous wealth for its shareholders, it's still not quite able to deliver the same returns on invested capital as General Dynamics.
I like to think of Ecolab (ECL) as the Cintas (CTAS) of soap. The firm has a large distribution network through which it provides a slew of cleaning and sanitizing products and services to major restaurant chains, hotel chains, hospitals, and retail outlets. It is the sole player in this space with sufficient scale to serve its customers on a global basis. It is also now the only large player to have a direct distribution model, as its next largest competitor, Johnson Diversey, withdrew from the direct-distribution market in mid-2006.
Precision Castparts (PCP) would be the one. Aircraft orders remain robust, with Precision executing nicely. Its recent acquisition of SMC continues to outperform expectations, with operating margins in the division now expected to rise to 20% by fiscal 2008 from the midsingle-digit range when the acquisition was announced in August 2005 (it closed in May 2006). The 20% level would be above companywide operating margins, which are in the high teens, so this is impressive.
Rockwell Collins (COL) makes avionics suites that span the gamut of platforms, including military helicopters, fighter planes, Boeing commercial planes, regional jets, and even business jets. The firm's incumbent status as the electronics provider of choice gives it an advantage over competitors as plane manufacturers and pilots are loath to switch based on the costs and training involved. Rockwell is continuing to extend its advantage by investing in next-generation solutions, and some of this research and development is supported by the government, which commissions the firm to produce sophisticated military avionics.
Once Rockwell has developed a system for military use, it leverages that technological expertise to build similar commercial systems. In addition, the firm's products are often used by competing aircraft manufacturers so Rockwell is often agnostic in regard to shifts in market share, benefiting from the long-term growth in overall air travel. Returns on invested capital, averaging more than 16% the last six fiscal years, well exceed Rockwell's cost of capital, and the firm is a cash-generating machine, with free cash-flow yields in the 10%-13% range.
Carpenter Technologies (CRS) is great little niche player in the fast growing specialty metals sector. The company has exposure to the aerospace, energy and health-care markets; all are expected to be highfliers over the next 5-7 years, and it has been raising prices seemingly at will over the past few years. Over the past three years, operating income has grown annually by 150% on average, and although we expect that growth to slow, we still expect pretty strong performance.
The longer I cover the aggregate guys, the more impressed I am by Vulcan Materials' (VMC) business model. Half of sales go to government-supported infrastructure. One fourth is residential construction and one fourth is nonresidential construction. There is a high-fixed-cost portion of the business that helps on the upside. Even when volumes are down year over year, pricing is very rational due to local oligopolies. Pricing has been absolutely tremendous over the past three years, and yet the cost of stone is still a very small portion of total construction costs. There are no economically viable substitutes.
Aggregate firms find land on the outskirts of a city, feed construction projects with stone as the building comes toward the quarry, and sell the real estate for very nice profits after they're done mining and have filled the quarry with water. Stone is too inexpensive relative to weight to support much in the way of overseas imports. U.S. infrastructure is dated and crimping the economy in many areas, and funds are starting to flow to fix this problem, especially in California, which benefits Vulcan. Until we invent mass-market hovercraft, the moats around these companies will last for a long time.
Toan Tran does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.