4 Bargain Stocks In An Already Cheap Sector

StreetAuthority Network

A surging stock market has given the impression that the U.S. economy has made up for lost time over the past five years. But don't confuse asset prices with economic activity. The vast majority of companies have sought to restrain spending, limiting capital expenditures in the face of a still-wobbly economy.

That flies in the face of historical patterns. In the past, as the economy exits recession, capital spending starts to rise, often hitting a peak in the next three to four years before the next inevitable pullback from the cyclical peak.

This time around, the move toward a peak still lies in the future, perhaps into 2015 and 2016. And since we're exiting a long phase of underinvestment in capital spending (what economists call "PP&E," short for plants, property and equipment), companies will need to embark on an extended phase of higher capital spending, once the cycle kicks in. Instead of a cyclical peak lasting 18 to 24 months, as has been the case in the past, we may be looking at a peak that extends for three or four years.

In that context, many industrial stocks are poised for better results in a year or two, and perhaps really strong results as we head into the latter half of this decade.

Notably, many of these industrial stocks, even as they have moved up sharply from their lows, still trade for very reasonable valuations. Here's a look at four industrial stocks trading at price-to-earnings (P/E) ratios of less than 10 times projected 2015 profits.

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1. Owens-Illinois (NYSE: OI)     
2015 P/E: 9.8

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This company, which makes a wide range of packaging products, saw its annual sales peak at $7.5 billion back in 2007 and 2008, with free cash flow near $400 million in those years. Yet sales and free cash flow have yet to revisit those levels: Sales are currently stuck roughly $500 million lower, and free cash flow in 2013 was around $320 million.  

In the face of top-line headwinds, management has been holding the line on expenses, so margins have stayed constant. As the cyclical portions of the U.S. economy strengthen, look for a moderate gain in sales and, with a little margin leverage, more robust profit growth. For example, EPS is expected to rise more than 10% in 2014 and 2015, and a firmer economy by 2016 should help profits to grow at least at that pace.

 

2. Whirlpool (NYSE: WHR)    
2015 P/E: 9.9

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In tandem with the ongoing housing slump and a still-insecure global consumer, demand for Whirlpool's "white goods" (washing machines, dishwashers, dryers) remains below the previous peak. Sales hit $19.4 billion in 2007 and are only expected to return to that level this year, even though Whirlpool has expanded into a dozen new markets since then.

Even before sales eventually move to new peaks in tandem with a firming global economy, management has already proven their ability to hammer down costs, thanks to more streamlined manufacturing processes. EBITDA margins, which hovered in the 6% to 9% range in the past decade, moved up to 10.6% in 2013.

Analysts think sales will only slowly move higher -- around 3% growth is expected this year and 6% in 2015. But the firmer margins mean profit growth is likely to be much more impressive, growing at a 15% to 20% pace. If the housing market enters into an extended upturn in 2015, as many expect, then sales and profit growth can move far higher.

 

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3. AK Steel (NYSE: AKS)      
2015 P/E: 7.6

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Back in 2007 and 2008, this steelmaker's annual revenue base exceeded $7 billion. In 2013, sales slumped to just $5.6 billion. Adding insult, the company lost money for the fifth straight year.

But signs of an upturn are at hand. A combination of cost cuts and modest sales growth is expected to lead to a $0.45-a-share profit this year, and perhaps twice as much next year. Still, analysts don't expect sales to climb back to the $7 billion mark for at least another couple of years. Per-share profits in excess of $1 become a real possibility when sales return to that past peak. Shares, recently trading below $7, were far higher in past peaks, moving above $20 in the 1990s and again in 2007.

 

4. Ford (NYSE: F)     
2015 P/E: 8.0

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I have continued to recommend shares of Ford throughout the past few years, even as shares hit fresh 52-week highs and even when they've moved back out of favor. That's because the financial turnaround at this automaker is nothing short of remarkable -- and even better days lie ahead.

Though Ford's sales base of $146 billion in 2013 was roughly $30 billion lower than it was in 2005, net profits of $7.1 billion were actually 300% higher. Back in 2005, Ford generated a 10% return on equity. In 2013, that figure exceeded 30%.

Another impressive stat: though Ford's 2013 sales base was 15%-20% lower than it was in 2005, its headcount shrank nearly 40%, from 300,000 in 2005 to 181,000 in 2013. Like many other automakers, Ford's factory floor productivity (measured in cars produced per employee) continues to hit records.

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Risks to Consider: It's fair to question why a capital spending boom isn't already underway. Companies should be making heavy investments in PP&E right now, but they are not. Most economists think that corporate planners simply need to see that the global economy is on sound footing. But until that happens, the capital spending drought may persist.

Action to Take --> Industrial stocks represent one of the few corners of the market where bargains abound. To be sure, these stocks have moved well higher from the 2008-2009 lows, but they also often remain below prior peaks. It's unwise to expect huge gains for these stocks, as they will never have high P/E multiples, but when you consider that the next economic cyclical peak could last for quite awhile, then these industrial companies should be poised for steady and sustained growth.

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