Industrial stocks have lagged the market both year-to-date and over the past year, but the time may be ripe for a turnaround. Brian Belski, chief investment strategist at BMO Capital Markets Corp., has an overweight rating for the sector, citing a "solid fundamental backdrop" that includes steady U.S. economic growth, according to a report in Barron's. While the article did not cite his specific stock recommendations, the leading stocks in the sector are 3M Co. (MMM), United Technologies Corp. (UTX), Honeywell International Inc. (HON), Union Pacific Corp. (UNP), FedEx Corp. (FDX), United Parcel Service Inc. (UPS) and Lockheed Martin Corp. (LMT).
The stocks listed above are among the 10 largest holdings of the Industrial Select Sector SPDR (XLI), per Morningstar Inc. That ETF is down slightly this year while the S&P 500 Index (SPX) is up by 1.5%. The industrials look better for the year through May 18, up by 13.9%, but still slightly behind the S&P 500, per CNBC.
Sources: CNBC for individual stocks, The Wall Street Journal for the S&P 500.
'Strong Earnings Backdrop'
Belski says that industrials offer attractive valuations right now even though several have ratios higher than the S&P 500. They "remain well-positioned to provide leadership for the market in the coming years," he says. Specifically, he likes the sector's returns on equity, cash flow, and forecasts of double-digit earnings growth through 2019, per Barron's. The fact that earnings estimates for 2019 have not declined, despite the recent drop in stock prices among industrials, is taken by Belski as an indicator that the earnings backdrop for the sector remains strong.
Honeywell illustrates this. The company is a diversified manufacturer of products used in applications that include autos, aircraft, buildings, and business processes. EPS growth is forecast to be 12.1% over the next year, and to average 9.3% annually over the next three to five years, per CNBC. First quarter 2018 EPS of $1.89 missed the consensus estimate by one cent.
Package delivery service UPS is another. The company beat the consensus estimate of $1.54 EPS in the first quarter by one cent, per CNBC. The projected one-year growth rate is 17.8%, and the average for the next three to five years is 8.3%. Bank of America Merrill Lynch has issued a buy rating on the stock, largely based on a cost reduction program that includes automation and a voluntary management reduction program. BofA Merrill Lynch's price target of $144 is 24% above the May 21 open.
GE and Caterpillar
Not all industrial stocks may be a sure bet, however. The top 10 holdings in the Industrial Select Sector SPDR also include troubled conglomerate General Electric Co. (GE), down 12% YTD, and construction equipment maker Caterpillar Inc. (CAT), up 1% YTD. Despite announcing first quarter earnings that handily beat the estimate by 33%, the outlook for Caterpillar has been clouded by concerns over rising input costs, mainly the result of President Trump's tariffs on imported steel, and insufficient pricing power to pass them along to customers.
Zachs Investment Picks
Zacks Investment Research Inc. also has named five U.S. and international stocks that should benefit as manufacturing activity rises. These are Hitachi Construction Machinery Co. Ltd. (HTCMY), cement maker China National Materials Group Corp. (CASDY), services and engineered products company Harsco Corp. (HSC), steel pipe and services supplier to the energy industry Tenaris SA (TS), and copper electrical wire maker Encore Wire Corp. (WIRE).