Industrials: Stocks Remain Fully Valued, but Opportunities Remain Across the Sector

The Morningstar US Industrials Index has performed in line with the US Market Index over the last 12 months. Industrials continue to benefit from stocks with exposure to the artificial intelligence buildout. The sector has been riding themes like reshoring and higher defense spending, but these themes have come under pressure in recent months.

While we view the sector as fully valued, compelling investment opportunities remain across most industry groups, particularly in aerospace and defense, business services, and construction.

We expect fundamentals in aerospace and defense to hold up relatively well, as healthy demand dynamics persist across both the commercial aerospace and defense markets. Aerospace should benefit from a growing aircraft fleet, and defense should benefit from increased defense spending. Aerospace and defense sectors have seen a correction in recent months, making valuations more attractive. The AI buildout should drive continued growth for several names in the sector, but much of the upside is already priced into stocks heavily exposed to the theme.

Continued geopolitical turmoil should impact the sector, given its exposure to energy and raw material prices, supply chain disruptions, and production constraints. Inflation remains persistently above Fed targets, and higher-for-longer rates look increasingly likely. High interest rates are a major headwind for industries like construction, building materials, and homebuilding. We maintain a cautious outlook for rate-sensitive industries in the sector, but near-term market worries have unlocked attractive investment opportunities in this area.

Sticky inflation and an uncertain economic outlook may force the central banks to tighten monetary policy, keeping interest rates high. Recent trends in industrial production and capacity utilization have been encouraging, especially in the current rate environment. AI buildout, reshoring, and tariff-protection themes have supported the sector. Resilience in industrial production is starting to be reflected in fundamental drivers of various industries, like pricing for trucking transportation.

Top Industrial Sector Picks

Vontier VNT

• Fair Value Estimate: $48.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

Vontier is an industrial technology company offering transportation and mobility solutions. While growth in convenience retail (roughly two-thirds of Vontier’s revenue) has been solid, weaker results in repair solutions have dragged down organic growth. The latter has faced headwinds due to a challenging macroeconomic environment, which has weighed on repair technician sentiment and pressured discretionary spending, particularly on high-ticket items. Nonetheless, we view these headwinds as transitory and expect repair solutions to return to more normalized organic revenue growth in the low single digits once macroeconomic pressures ease.

CarMax KMX

• Fair Value Estimate: $96.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

CarMax is the leading used vehicle retailer, with over 255 stores, all in the United States. CarMax has not resisted the shift to online retailing, but we think it has not done a good job of messaging its robust omnichannel capabilities to consumers. Once it revamps its website and improves its messaging, we expect sales to rise. Former IHG CEO Keith Barr became CEO in March, and we think the market is eagerly awaiting a deep dive into his four-pillar strategy this fall. The pillars focus on offering a broad selection with an easier online experience that complements the in-store experience, all while reducing overhead and reconditioning costs. Once Barr settles in, we expect share buybacks to resume.

Lennar LEN

• Fair Value Estimate: $120.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: High

Lennar is the second-largest homebuilder in the US. Lennar has become more asset-light, with 98% of its lots controlled via options. The stock has corrected about 50% from its 2024 highs as the rate outlook changed and the market became skeptical of Lennar’s long-term margin profile following its transition to a land-light strategy. Lennar’s margins may underperform in the near term, but its operating model and enhanced scale should enable it to close the gap with peers in the long run. The market is pricing the stock as if homebuilding margins will not improve from the current levels, which we think is excessively pessimistic.