Engineering and construction, also known as E&C, has lately been receiving great attention from investor circles given the cyclical upside, improving valuations and growth in sales in the industry. Similarly, the machinery industry has also been keenly followed lately given its cheap valuations and massive cost restructuring.
However, what baffles investors is the question: Which one is a better investment, E&C or the machinery industry?
E&C vs. machinery
Let’s compare both on five dimensions:
1. Cyclical Upside: The E&C end markets (especially U.S. petrochemical and LNG export) are still in the early stages of a multi-year up-cycle. There is good growth potential for some machinery end markets too like U.S. construction and gradually improving emerging markets, but others are either closer to peak (like agricultural equipment) or have already rolled over (mining).
2. Valuations: E&C stocks have run amidst a rising tide of new contract award chatter, while an as-expected weak 1Q, choppy global growth, and inventory concerns have left machinery stocks undervalued. The good news is expectations are low, and results could benefit as China ceases to be a headwind and a weak Europe is increasingly priced in.
3. Margin Improvement Potential: E&C oil and gas margins remain muted, but pricing in backlog has started to improve and a pickup in awards could support better utilization levels later this year. As far as the machinery companies are concerned, while margins are not expected to fall off, there are relatively fewer opportunities for incremental upside.
4. Core Growth: E&Cs with good secular stories, such as Chicago Bridge & Iron (NYSE:CBI), MasTec, Inc. (NYSE:MTZ), and Fluor Corporation (NEW) (NYSE:FLR) are best positioned in the current environment. Some machinery names with share gain potential and longer-term secular tailwinds also come under this category. However, cyclical pressures could temper near-term core growth.
5. “Self Help” Potential: Several of the machinery companies like Terex Corporation (NYSE:TEX), Illinois Tool Works Inc. (NYSE:ITW), and Joy Global Inc. (NYSE:JOY) are more inclined to pursue cost cutting, restructuring and cash deployment initiatives to help support/grow earnings. E&Cs haven’t historically been as successful in this area, but there some names that could surprise to the upside.
Company-specific overview
Chicago Bridge & Iron (NYSE:CBI) seems to score highly across all five categories (with top billing in four out of the five). It remains perhaps best positioned to benefit from a ramp-up of U.S. petrochemical, LNG export, and gas processing work, beginning in earnest later this year and into 2014, which should support good visibility regarding longer-term backlog/earnings growth. The stock has run and is a consensus long, but it remains relatively inexpensive at about 12.5x 2014 EPS estimates vs. the group at 12.5x on average and still has significant longer-term upside potential.
Manitowoc Company, Inc. (NYSE:MTW) is expected to benefit from cyclical upside and margin improvement
For Manitowoc Company, Inc. (NYSE:MTW), a combination of a continuing (and maturing) rebound in crane markets, steady improvements in food service, and significant debt pay-down could drive earnings materially higher over the next couple of years. There is a high confidence level in a continuing recovery in Manitowoc Company, Inc. (NYSE:MTW)’s primary crane markets (both in rising orders and margin). The higher-margin large crawler crane demand is picking up, and combined with some fleet rationalization from crane rental companies and company-specific actions to control cost, should allow Manitowoc Company, Inc. (NYSE:MTW) to meet or beat investor expectations for 2013 and beyond.
Self-help and core growth is expected in Terex Corporation (NYSE:TEX)
Terex Corporation (NYSE:TEX) was recently upgraded by Barclays PLC (ADR) (NYSE:BCS) to buy. Barclays PLC (ADR) (NYSE:BCS) sees good opportunity for continued share appreciation. Terex Corporation (NYSE:TEX) has good “self help” potential and has demonstrated solid progress toward its goals of better execution, margin improvement, and debt pay-down. Combined with more realistic near-term expectations relative to its European exposure, Terex Corporation (NYSE:TEX) seems to be well positioned to drive further core earnings growth given continued strength in its Aerial Work Platform (AWP) business and still-improving crane fundamentals led by a pickup in energy and infrastructure activity.
Final word
Many investors have significant trepidation to invest in the E&C space. Generally, machinery is viewed as a higher quality/more investment-worthy sector. After boiling the debate down to the most discussed issues – cyclical upside, valuation, margin improvement, core growth, and “self help,” E&C interestingly appears to be the more attractive sector in three of the five categories.
Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Which Is a Better Investment: E&C or Machinery? originally appeared on Fool.com is written by Zain Abbas.
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