Playing The Capex Cycle: Global Electrical Equipment Stocks
After a disappointing 2012, courtesy of fiscal cliff fears in the U.S. and the slowdown in global growth, U.S. business investment (capex) has come back to life this year. MRB expects further solid gains ahead, which bodes well for a broader rebound in global fixed investment, given the leading tendency of the U.S. The global industrials sector, particularly the capital goods industry, will be a key beneficiary.
Our top pick within the capital goods industry remains global electrical equipment companies, which offer leverage to the capex cycle at an attractive valuation. Global electrical equipment stocks have mildly outperformed the overall market year-to-date. With relative valuations still at the low end of their range, the industry is well positioned for further relative upside as economic conditions improve.
Electrical equipment companies sell a broad array of goods including: generators, turbines, motors, automation equipment, heating ventilation and air conditioning units, and lighting fixtures. Demand for these items is sensitive to the global manufacturing and investment cycles. The acceleration in electrical equipment orders should be gradual, given lingering uncertainties about global growth. However, with the order cycle depressed, there should be a fair amount of pent-up demand released as end markets such as commercial construction and industrial automation gradually revive. In addition to cyclical tailwinds, the industry will benefit from secular opportunities such as the growing global need for power consumption efficiency, rising investment in renewable energy sources, and the build out of energy infrastructure in emerging markets.
Consistent with a bottoming in order rates, relative forward earnings momentum for electrical equipment stocks has improved slightly and is poised to gain momentum. Cost-cutting helped maintain relative ROE at elevated levels during last year’s global slowdown, implying good earnings leverage once orders rise and production volumes improve.
Global electrical equipment stocks have usually traded at a large premium to the broad market on a forward P/E basis. Recession fears have almost completely unwound the sector’s valuation premium, thus creating an attractive opportunity for investors with a 1-2 year horizon.
In sum, a re-rating in electrical equipment stocks looms as the global economy transitions to better growth and capex strengthens. Investors should stay overweight and add to positions on pullbacks.
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Salvatore Ruscitti, MRB – The Macro Research Board