Baird Turns Positive On Machinery Stocks, Upgrades Caterpillar, Manitowoc, Sun Hydraulics

Machinery stocks have meaningfully lagged behind the diversified industrial stocks as well as the overall market, rendering an attractive risk-reward proposition, according to Baird.

The Analyst

Analyst Mircea Dobre upgraded shares of machinery stocks Caterpillar Inc. CAT, Manitowoc Company Inc MTW and Sun Hydraulics Corporation SNHY.

• Caterpillar: upgraded from Neutral to Outperform, price target raised from $155 to $191.
• Manitowoc: upgraded from Neutral to Outperform, price target raised from $27 to $32.
• Sun Hydraulics: upgraded from Neutral to Outperform, price target raised from $50 to $65.

The Thesis

Notwithstanding continued positive revisions, capital goods stocks — and especially machinery stocks — have experienced valuation multiple compression, Dobre said in a Thursday note. (See the analyst's track record here.) 

Within the capital goods space, machinery stocks are near record discounts versus diversified industrials, the analyst said. 

The multiple rerating was brought about by trade wars and related uncertainty along with a growth peak, Dobre said.

With these factors now priced in and the multiples bottoming, the analyst expects fundamentals to drive stock action once again.

"The near-term picture is still robust as demand remains solid, pricing is coming through to support [second half of 2019] margins with raw materials plateauing," Dobre said. 

Baird sees the setup into the year-end as favorable on the basis of a rollover in steel prices; OEM price hikes rather than surcharges; seasonality; the aftermath of midterm elections; a pause in the dollar rally; and the material underperformance of capital goods relative to still-tight high-yield spreads.

Caterpillar's Demand Mostly At Midcycle Or Below

Baird expects demand growth for Caterpillar to continue into 2019, with over 60 percent of its sales at midcycle or below. Capital deployment is a catalyst for the company, Dobre said. 

Manitowoc: Looking To 2019

Manitowoc has executed well throughout 2018, with continued margin expansion, the ability to manage supply chain constraints, order growth and share gain, Dobre said. Although the analyst expects cost-related pressures in the fourth quarter and first quarter of 2019, Dobre said outright price increases and stabilizing or declining input costs should help in the second half of 2019.

Sun Hydraulics' Headwinds In Rearview Mirror

With cost headwinds now behind Sun Hydraulics, Baird expects price increases to support organic and margin growth in the fourth quarter and in 2019. 

"Valuation now largely in line with group median in spite of a more attractive growth/margin profile (25-percent EBITDA growth in 2019)." 

The Price Action

Caterpillar shares were up 0.62 percent to $156.99 at the time of publication Friday. 
Manitowoc shares were down 0.46 percent at $26.23. 
Sun Hydraulics were up 1.84 percent at $58.03. 

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