Goldman Doesn't Believe In Multi-Industry Group Recovery, Downgrades 2 Stocks

Goldman Sachs lacks confidence in the multi-industry group rally, which has outperformed the S&P by 9.7 percent since January 1 after "underpacing the market for two years in a row" (-10.3 percent/-8.3 percent in 2014/2015 vs. S&P). The multi-industry group is now trading at a 12 percent premium to the S&P compared to its typical 5 percent premium.

But Goldman says although there have been positive data points supporting the rally, there is no enough underlying improvement to justify the current multiples.

"While FY16 EPS has been lowered materially (-18 percent since the start of 2015) and organic/EPS growth improve as comps ease throughout the year, we think it is time to put the brakes on the rally," analysts, led by Joe Ritchie, wrote in a client note.

The analysts highlighted that investors have underappreciated three key points: "(1) This has not been an industrial recession, (2) Growth implied by current multiples is improbable, (3) Inventory levels remain elevated."

Related Link: Buy Honeywell Over GE? This Analyst Is

"Lastly, bottom-up capex of GS covered sectors that matter to Multis growth indicate deceleration in 2016 vs. 2015 (down DD vs. down HSD in 2015) and for capex growth to remain negative in 2017, supporting our expectation for a 'low and slow' recovery," the analysts added.

"While we had been advocating a barbell approach, we now believe it is time to get more defensive given our view that this rally is unlikely to be sustained," the analysts continued.

A Few Names

Goldman downgraded Parker-Hannifin Corp PH to Sell and Ingersoll-Rand PLC IR to Hold on valuation.

The brokerage, which has a $92 price target on Parker-Hannifin shares, said, "We believe PH shares are pricing in a recovery that we do not expect to materialize. Valuation is stretched, we see bottom-quartile EBITDA/organic growth in 2016/17E, and there is limited B/S capacity. Given how late we are in the cycle, we believe PH's multiple will revert when short cycle data points do not corroborate the recovery being priced in."

Meanwhile, Goldman has a $64 price target on Ingersoll-Rand and has the following view on the stock, "We appreciate IR's leverage to commercial HVAC, productivity/ self-help initiatives, and a unique price/cost tailwind that should offset a weaker Industrial. However, at 15.4x P/E NTM, IR is trading above historical averages, and we believe risk/reward is balanced at these levels."

Goldman's top picks in the sector are Honeywell International Inc. HON and Illinois Tool Works Inc. ITW.

Goldman analysts noted that Honeywell is "on track to outperform their coverage on several key financial metrics. From 2015–2017, they expect top quartile EPS growth (+10 percent), FCF growth (+12 percent), and returns improvement."

In addition, they added, "HON has potential balance sheet firepower to drive > $9 in EPS by 2018, implying a 14 percent CAGR for an $86 billion mega cap stock."

On Illinois Tool Works, Goldman "expects ITW's self-help story to drive top-quartile 2015–2017 margin expansion and EPS growth (+9 percent CAGR) with minimal reliance on topline growth.

Goldman has a Buy rating on Honeywell and Illinois Tool Works, with price targets of $126 and $110, respectively.

Image Credit: Public Domain