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Tickers in this Article: TKR
The wheel, as often asserted, is the greatest invention ever.

Adhering to similar logic of roundness, the ball-bearing -- that often invisible marble used to reduce friction between engine and machine parts -- is perhaps the next greatest invention.

The leading manufacturer of this utilitarian apparatus is Timken (TKR), which operates in 27 countries with annual sales of about $5 billion and a market capitalization of around $2.8 billion.

The company offers sundry incarnations of this indispensable orb in roller, precision cylindrical, spherical, and needle form.

The bearing-making business, like most industrial businesses, is cyclical.

The challenges the bearing business face include a secular bull market in commodity prices, which has lowered margins on many goods. Steel and copper, in particular, have seen dramatic increases.

The cyclicality, if not unpredictability, of the business can be readily seen in Timken's return on invested capital (ROIC), which often seems to wander about like some efficient market hypothesis of a staggering drunk.

In 2005, Timken's ROIC improved to approximately 13% in 2005 from a low of 8% in 2002. Meanwhile, its ROE climbed to a 10-year high of 18.8% in 2005 from a low of 4.3% in 2003, only to slip back to 11.7% for 2006.

The current position in the business cycle is likely closer to a bottom than it is a top. Timken experienced a steep decline in EPS in the most recent quarter, reporting fourth-quarter earnings of $35.3 million, or $0.37 a share, 63% below the year-ago figure. For all of 2006, the company posted $222.5 million in net income, or $2.36 a share, on $4.97 billion in sales. In 2005, it made $260.3 million, or $2.81 a share, on $4.82 billion in revenue.

A drop in earnings should came as no surprise given that 40% of Timken's revenues are generated from the automotive industry, which itself is somewhat wandering these days -- a fact which comes as no surprise, considering all the restructuring activities over the past two years.

Despite the woes in that segment, demand is expected to remain favorable in Timken's other segments, industrial and steel production, which should help the company's EPS rebound to management guidance of $2.50-$2.70 for 2007.

Valuation based on present and expected earning estimates seem reasonable. Assuming a 10% increase in EPS for 2007, 3.0% growth in perpetuity, and an 11% weighted average cost of capital (WACC), a $32 per share value can conservatively be derived.

Risks to my opinion include weaker than expected growth in Timken's markets, a slower than forecasted turnaround of its automotive operations, the inability to impart price increases and further weakening of the U.S economy.

That said, odds favor a recovery. I do not see any strong reason stemming from Timken's fundamentals that would cause a continuation of last year's stock price decline.

At its current prices, Timken's stock is trading at a slight premium to its 52-week low and at a 20% discount to its 52-week high of $36.25. It's also selling for less than its peers in relation to its current earnings, which means it will likely starting turning up on the stock screens of more value investors.

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