Believing in the Industrial Sector

 | Mar 08, 2013 | 11:00 AM EST
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Equities continue to close in on their 2007 highs on the S&P 500. The rally has been impressive given contraction in Europe, headwinds to consumer spending (payroll-tax holiday expiration, tax hikes on the affluent, high gas prices) and a dysfunctional U.S. political system. It is getting harder to find value with the recent run-up. Consumer staples are richly priced for value investors looking for defensive plays, and growth investors should be weary on stocks in the consumer discretionary sectors as I don't believe we have a good handle on how strong consumer spending will be this year yet.

On the brighter side, the housing market recovery seems real and construction activity is accelerating. In addition, I believe American manufacturing is gaining strength and has long-term advantages given its access to the lowest energy costs in the developed world. Investors can still find value and growth in the industrials that serve or operate in those sectors. I also believe that industrials will increasingly become a target of mergers and acquisitions given their valuation and growth prospects. M&A activity is off to its strongest start in several years, and this should continue given low financing costs, the huge amount of funds private equity firms are sitting on and the challenge larger firms have generating robust organic growth. Kohlberg Kravis Roberts' (KKR) takeover of Gardner Denver (GDI) is a good example of this activity. It's the third industrial company KKR has bought in the last few years.

Here are two stocks in the mid-cap space that I like for their valuation and growth prospects.

URS Corp. (URS) provides engineering and construction services to public agencies and private-sector clients. I first profiled this company last summer when it was trading at $35 a share. The stock has climbed more than 20% since then but the shares still look undervalued. URS is selling at less than 10x expected earnings this fiscal year and analysts expect almost 10% revenue growth for 2013. The stock is priced at less than book value and pays a dividend of 1.9%. If we do eventually get any sort of infrastructure stimulus package out of Washington, URS would be a primary beneficiary given its extensive client base of federal and state agencies.

The Manitowoc Co. (MTW) designs and manufactures cranes, as well as foodservice equipment. This stock has doubled since its bottom last summer; however, the stock is selling at roughly 40% of highs achieved before the financial crisis. It is still recovering from an ill-timed acquisition of food service equipment maker Enodis in 2008. It has paid down a substantial portion of the debt issued for this purchase and the acquisition does provide diversification from its core crane business. Although the company gets a little more than half of its revenues from this part of its business overseas, it also benefits from the increased construction activity in the U.S. After being dormant for years, large-scale construction in the U.S. is returning. In downtown Miami there are five new condominium skyscrapers going up within a three-minute walk from where I live. MTW's revenue growth is expected to be in high single digits for the next two fiscal years, and the stock has a five-year projected price-earnings-growth ratio of 1. MTW is priced at less than 11x 2014's projected earnings.

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