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Industry Outlook: Big Firms May Fare Better in Slowing Economy

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Diversified companies like General Electric and 3M are best able to weather slowing domestic economic conditions--which is how 2007 appears to be shaping up, analysts say.

For example, Scotch tape and Post-it note maker 3M also makes products for the construction and automotive industries. While those markets are seeing slower growth, the company should benefit from the sale of its products for aerospace and power generation markets, which are expected to perform well in the year ahead.

"That's where diversity comes in," notes Morningstar analyst Scott Burns.

"In general, this is a pretty good group to hide out in when you look at the macro environment," says JP Morgan analyst Stephen Tusa. He points to Danaher, for example, which stayed on top during the last recession, outperforming less diverse companies.

While experts aren't unanimously predicting a recession ahead, many are expecting slower domestic growth.

GE's robust overseas sales could buffer it from a U.S. slowdown. Goldman Sachs analyst Deane M. Dray recently upgraded GE to "Conviction Buy" from "Buy." GE is the parent company of CNBC.

Diversified Companies

"At this point in the cycle, in a moderating growth operating environment and greater uncertainty in the industrial sector, we believe investors will gravitate to GE's late-cycle exposure, high-margin services mix, emerging markets strength, and attractive earnings visibility/consistency," Dray wrote in a note to investors.

Growth May Have Peaked

But Morgan Stanley analyst Scott R. Davis believes four years of strong financial and stock growth from many electrical equipment and industrial conglomerates may have peaked in 2006, and could decline in the months ahead, according to a recent client note. He cut his view of the sector to "In-line" from "Attractive."

"Our downgrade may be early, but profit-taking in many of the more expensive names in the group seems prudent," he said.

High-priced acquisition and merger deals indicate "potentially irrational behavior," which is usually a precursor to slowdowns, wrote Davis. In addition, high sales growth may be hard to sustain, while year-ago comparisons have become difficult due to past strong performance.

"Regardless of stellar top-line reports, the stocks no longer seem to be responding positively to these results," Davis notes.

General Electric, for example, has barely seen its stock budge from the beginning of the year despite the company's consistent profit results in the last several quarters. Davis believes GE stock has underperformed for the past few years due to pricey acquisition deals, but still recommends the stock to investors.

JPMorgan's Tusa says Dover, 3M and GE are priced cheaply, while Textron is reasonably valued. Analysts agree that Danaher, while retaining strong growth prospects, is currently overpriced. Citigroup analyst Jeffrey Sprague recently cut his rating on Danaher to "Hold" from "Buy" based solely on valuation.

Bullish Predictions

While analysts and investors may be cautious on 2007, most of the blue chips are anything but. General Electric reaffirmed earlier this month it expects earnings to increase 15% to 16% in 2006, and sees double-digit earnings growth for 2007. The stock touched a new 52-week high shortly after the company issued the bullish guidance.

"I think there's even better news ahead," GE Chairman and CEO Jeff Immelt said at the company's annual outlook meeting in New York on Dec. 12. "What we've tried to build and what we're building is a reliable growth company, not just strong in the short term but well positioned for next five years."

Fellow conglomerate United Technologies also is upbeat on 2007, despite feeling the effects of a slowing U.S. housing market. The company expects strength in sales to aerospace and commercial construction markets also to help offset the pressure of high commodity prices.

And Honeywell Chairman and Chief Executive David Cote recently forecast double-digit growth for 2007, saying the company's "strong positions in industries with favorable macro-trends and attractive long-term prospects are expected to more than offset modest softening in global economic conditions."