Monday, September 09, 2013

Investing In Industrial Goods

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There are signs the global economy is finding firmer footing. The August JP Morgan Global Composite Output Index rose 1.2 to 55.0, hitting a two and half year high. Moreover, the August U.S. employment report showed aggregate hours worked rising 2.4% from last year despite disappointing job creation. The boost in hours worked is consistent with the strength in the U.S. ISM production indices which were the strongest going back to 2011.

Signs of reviving economic growth argue for an examination of stocks with exposure to the industrial sector. Graham Corporation (GHM), Zacks Rank #1 (Strong Buy), fits the profile. Graham designs and manufactures vacuum and heat transfer equipment for energy and industrial markets. It has a small dividend yield of 0.34%.

A growing small cap:

Graham is a small cap with a value of just over $350 mln and is expected to post sales of $111 mln in the fiscal year ending March 2014 and $127 mln in the fiscal year ending March 2015. Sales are projected to accelerate and grow 14% between fiscal years 2014 and 2015 after rising 5.7% between fiscal years 2012 and 2013. The company has a goal of doubling organic revenues and achieving sales in excess of $200 mln at the next cycle peak.

The majority of sales, 53%, are in the U.S., but Graham has clear international exposure with 19% of sales coming specifically from Asia. By Industry, the biggest sales are generated from refining (39%), power (23%), and chemical/petrochemical (22%). It may be an indirect play on the growth in natural gas usage in the U.S. It also has exposure to the U.S. Navy’s nuclear propulsion program. Given the geopolitical tensions in the Middle East, the Navy is likely to be active and a focus of military spending.

Financial strength:

Financially, Graham has a history of strong free cash flow generation and is showing limited debt on its balance sheet. It has the capacity to fund organic growth and acquisitions. The market is pricing a bright outlook for the company. It is trading at 26.4 times forward 12 month earnings, but has a more reasonable PEG ratio of 1.47.

Earnings estimates biased higher:

Earnings estimate revisions have been benign over the last 30 days, but are up $0.12 to $1.16 for the fiscal year ending March 2014 and $0.22 to $1.56 for the fiscal year ending March 2015 over the past 90 days. EPS growth is projected to be a vibrant 34.4% between fiscal years 2014 and 2015. The price to consensus earning chart shows earnings per share estimates stair stepping higher between fiscal years 2012 and 2015.

Concluding thoughts:

Grahman’s exposure to the defense, energy, and industrial sectors fits well with the current upswing in economic growth and the landscape of geopolitical uncertainty in the Middle East. This small cap may be food for thought when you are thinking about your portfolio.

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