Following a tumultuous week in industrials, I wanted to add some colors on why we are underperforming in our Select Equity industrials portfolio and some actions we are taking:
- Adding 50bps each in HON and XYL from cash/IVV: long-term thesis and drivers are still in place; we expect to see a recovery in aerospace (HON) and continued spending by utilities towards clean water across the globe (XYL). Recent supply chain issues are temporary.
- Both should see their multiples expand as they see base business recover from recent turbulences & monetize their growing software offerings over time
- On a DCF basis, HON and XYL have the most upside from current levels
Why is our Industrial sector underperforming?
- Highly cyclical names have outperformed since early 2021 (airlines / construction)
- We don’t have highly cyclicals names in industrials portfolio
- XYL, ST, FTV and HON are high quality names with good growth drivers
- “green” stocks have underperformed (after outperforming in 2020) – in part due to:
- Rising interest rates (inflation) means higher cost of doing business for non-profitable businesses is tough to weather (think solar/renewable energy companies)
- Investor getting out of those names into more cyclical companies: I think XYL was thrown out with the bath water – our worst performer YTD in Industrials
- Multiple contraction & delay in transforming orders into sales due to supply chain issues
- Defense names have done better due to Russia/Ukraine fear. Reminder that LMT top line and FCF profile is not as attractive as it was pre-2021: expect top line decline in 2022 and low 2% growth in 2023 with FCF drop in 17% drop in FCF in 2022 and 2% growth in 2023…not exciting
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
Crestwood Advisors
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Suite 500
Boston, MA 02109