Contrarian ideas always exist in the market and this is what brings spice to the world of equities. However, sometimes contrarian ideas can bring great fortune, if the investor gets it right. And it makes sense – greater risk eventually bears greater return.
Industrials have always been a stable sector. By stable, I mean there is not as much volatility to see as one can see in the tech or consumer-goods sector. However, that doesn’t mean this industry lacks contrarian ideas. Let’s have a look at one of the ideas that diverge from that of the Street.
Security segment of this company gets scrutinized
Ingersoll-Rand PLC (NYSE:IR) recently announced to spin-off its security business given the softness in commercial construction markets. This division formulated 11% of company’s revenue in 2012.
Ingersoll-Rand PLC (NYSE:IR) remains a top pick for 2013 and over the medium term given its exposure to cyclically depressed markets with substantial organic upside through its construction segment. Moreover, there is scope for market share gains from new product launches, like heating, ventilation and air conditioning (HVAC) and M&A activity like spinning-off of its security branch.
There is substantial self-help opportunity on costs/margins for Remain Co (Remain Co has been a term used frequently by Street to refer to Ingersoll-Rand PLC (NYSE:IR) after the spinning-off of its security branch.) Capital structure improvement is expected through increased debt financing from both Remain Co and the security branch.
Last but not the least, attractive capital distribution to shareholders (buybacks/dividends) are expected in the future from both Remain Co and the security branch. Ingersoll Rand started its buyback slightly earlier than what the Street had anticipated. Ingersoll announced $2 billion authorization in December 2012 and started buying back stock in April. Targeted completion is for 1Q 2014.
The dividend payout is targeted to reach peer payout ratios in 2014. Most of the shareholder friendly actions are coming in order to keep strong activism at bay, which has lately been bothering the management.
The company recently filed a Form-10 Registration Statement that stated that the completion of the transaction requires further work on structure, management, governance and other significant matters. Hence, it will take another five-to-six months to formalize everything. As the split draws near, the valuation multiple will expand given the premium ascribed to pure plays such as Lennox International Inc. (NYSE:LII) and Assa Abloy.
Where the idea diverges from the Street
The crux of the discussion is how this idea is contrarian to what the market thinks. It is interesting to note that the stock trades at a multiple of 16x, which is well below the 22x multiple at which S&P 500 trades. This is because the stock has got a beating due to its recent poor performance. The Street believes that sluggishness in non-res construction markets means that the company has a bleak outlook for the year. Also it believes that price tailwinds are expected to moderate in the later part of 2013.
However, what the market is currently ‘under-appreciating’ is that Ingersoll’s security brands — Schlage, Von Duprin and LCN — are leaders in the market. Also, in Europe and Asia, these brands hold key positions. Despite that, the business claims only 6% to 7% market share globally (out of a $30 billion addressable market) and hence there is a lot of room to expand. A more levered balance sheet (gross debt/EBITDA is set to be ~3X), and a likely acquisitive strategy will drive substantial share gain opportunities through M&A activity.
Competition
Tyco International Ltd. (NYSE:TYC), in a recent presentation, noted that non-res construction is experiencing slow recovery, which is being offset by European weakness. However, I am still bullish on the company. The management is continuously trying to innovate in order to curb softness in the non-res construction markets. The company has a strong reputation for turning around its operations.
