A handful of small- and mid-cap industrial stocks may rise as much as 82 percent in the next year, S&P Capital IQ analysts predict. They say the companies' sales growth will accelerate because of demand from fast-growing emerging markets and a recovery at home in the U.S.
The ratings firm also said in its research report released this week that the six firms it recommends will gain operating leverage, translating into bigger profits. As revenue rises, it will trickle down to earnings faster because of aggressive cost-cutting initiatives taken during the economic downturn of 2008 and 2009. What's more, the stocks are bargains, with depressed valuations.
S&P Capital IQ's equity analysts say the companies are trading at about 16 times their trailing 12-month earnings and significantly below 12-month share-price targets. The S&P 500 Index is down 0.85 percent this year, while the industrials sector has slumped 3.8 percent.
Here is a synopsis of the six firms that S&P favors:
1. Kelly Services, an employment-services firm with a market value of $530 million, gets high marks from S&P, as it says the company "has the most upside potential currently" of this group of stocks.
S&P Capital IQ's target price is a potential upside of 82 percent from its current $14.28.
Risks to S&P Capital IQ's recommendation, which are pretty widespread, are "a resumed global economic downturn, stagnation in labor markets, the company's inherently cyclical business."
And S&P said a potential cloud is that the company's chairman has a 90 percent voting control via a separate share class.
Offsetting these risks is Kelly's solid balance sheet with no long-term debt and strong free cash flow, according to S&P Capital IQ equity analyst Michael Jaffe.
He expects revenue growth to slow next year, although still rising 9 percent, after a projected 13 percent advance this year.
2. Manitowoc, a maker of heavy-duty construction cranes and commercial food-service equipment, shows potential upside of 75 percent from current levels, says S&P Capital IQ. The $1.5 billion market value company is currently trading at $11.29.
"Risks to the recommendation and target price include insufficient liquidity, a resumption of the downturn in the global economy, and the highly cyclical nature of the crane market," the S&P analysts say. The company added over $2 billion of debt to fund its October 2008 acquisition of a food-service-equipment supplier.
However, Jaffe believes a much higher valuation is merited because the company's crane business is poised to start a strong recovery, while its expanded food-service operations are in growth mode and will reduce the company's cyclicality.
He expects revenue will rise 19 percent in 2012, after a projected 15 percent gain in 2011. Crane sales will improve 29 percent in 2012 and food-service-equipment sales will advance 6 percent, after solid gains in both segments in 2011, Jaffe says.
3. Revenue for building-products supplier A.O. Smith is projected to grow 14 percent in 2012 after an expected 13 percent increase this year, according to S&P Capital IQ equity analyst Kevin Kirkeby.
The sales figures include a gain from a contribution by the Lochinvar acquisition completed in August, as well as the company's Chinese operations as the number of stores carrying its products has expanded significantly, he said.
Kirkeby thinks the stock has 49 percent potential upside. The risks to his recommendation and target price include weaker-than-expected new construction markets in the U.S. and China, higher-than-expected costs for raw materials and energy, and higher spending on new-product rollouts.
"This is offset by what we view as strong cash flow, diversification of customers and industries, and focus on high-growth international markets, notably China and India," Kirkeby said.
4. Pentair makes pumps for commercial and residential applications, including sump pumps, well pumps and fire-protection pumps. It's also a dominant provider of filters, pumps, and accessories for pools and spas.
The company has a $3.7 billion market value, thanks to a 6.4 percent gain this year and a three-year annualized return of 17.5 percent. It has a forward price-to-earnings ratio of a cheap 13.
S&P Capital IQ projects more than 8 percent sales growth in 2011 and 10 percent in 2012, as investments and innovation drive global demand for its water filtration and other products. "We expect overall strength to continue in developing regions such as China, India and Latin America," S&P says.
5. United Rentals rents and sells more than 600 types of equipment, ranging from heavy machinery to hand tools, at more than 700 locations in North America.
The company's shares are up 24 percent this year and have a three-year average annual return of 52 percent, giving it a $2 billion market value. It has a forward price-to-earnings ratio of 12.
S&P Capital IQ equity analyst Jim Corridore said in his research note that he thinks the economy is "near the start of a new cyclical upturn in nonresidential construction," and expects investors to rotate into United on brighter economic news.
"Given the tenuousness of the current recovery, many companies are opting to rent equipment, which is driving increased demand" for the company's rentals, "even without a booming economy," he says. He says that nonresidential construction has bottomed, and has as a "strong buy" rating on its shares.
6. Jacobs Engineering Group gets a "strong buy" rating from S&P based on the company's "diversified customer and geographic base, and its relationship-based business model, which focuses on relatively small, lower-risk projects rather than the large, competitively bid transactional projects sought by most of its peers."
"We also see favorable global trends in the oil & gas, chemicals, and buildings segments boosting the company's prospects," S&P says.
This investment is a play on a reviving economy boosting demand for construction projects.
Jacobs, which has a market value of $5.3 billion, has seen its shares fall 9 percent this year, but rise 8 percent over the past 12 months. It shares are currently trading at $41.55. It has a forward price-to-earnings ratio of 12.3.
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