Industrials May Be the Place to Be

 | Jan 17, 2014 | 7:06 AM EST
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If PPG (PPG) and Alcoa (AA) are any indication, then industrials are the places to be.

Lots of people were bemoaning the Alcoa quarter last week, mostly because of the earnings miss. That was, alas, the totally wrong takeaway of the situation. What mattered is the inexorable and inevitable mix toward more value-added products couple with lower-cost aluminum. It's a two-fold process and it is going along well as the company is becoming relentless in its pursuit of becoming one of the world's lowest-cost producers.

Before the much-maligned Klaus Kleinfeld, it was one of the highest. Kleinfeld's making all of the tough moves, closing old smelters that had sentimental attachment to the previous management, always reminding us how non-business-like previous management was. When the we get even the slightest inflection, whether it comes from Ford's (F) decision to go lightweight or Europe having a tick up for more than a month in car registrations, then you are going to see a bottom line that will shock you. You just haven't seen an ounce of leverage yet for the model and that's because the lack of pickup in sales. But there's no doubt in my mind that every region in the world, save China, is doing better right now than six months ago and that means when inventories are finally worked off and new, lower-cost facilities are in place, the amount of money that will be made off of a slight increase in sales could be shocking.

Don't forget why people really love the industrials. When they get it right they can beat estimates by 30%, 40% or even 50% if the analysts stay bearish.

PPG is just like Alcoa in my book. Did you notice how it immediately ticked down as if it had somehow blown the quarter? In fact, the quarter was pretty picture perfect, with the shifting of the product portfolio to higher value-added products continuing and the M&A continuing to percolate.

Of course, the company has to be aghast that any analyst would actually, seriously, be upset with that quarter. More importantly, this is the year where a huge part of PPG's business -- one-third of sales -- is about to turn. The conference call was laced with examples of European markets that troughed in a rolling way throughout the year, with the fourth quarter typically being the first good one in ages. PPG has cut and cut and cut and modernized and is now in a position, if I didn't know any better, to get about a 10% increase in profits from even a 1% increase in sales. Yes, it is that important.

Of course we all look at things so statically. A week ago people were calling for Kleinfeld's head when he didn't deliver an upside to earnings, even as the cash flow was fabulous, the cash position bountiful, the balance sheet the best in years and the revenues quite strong. Much of the business that has kept Alcoa back is in Europe. But I think Kleinfeld, who knows the European markets better than any American exec I know (remember he ran Siemens), is saying that we are at that inflection point right now. That's how his stock can now be above where it was after the so-called disappointing quarter.

PPG and Alcoa, two companies that missed that didn't miss at all.

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