Industrial stocks showing promise

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There are 13 stocks in the Industrials sector of the ASX 100 – ignoring the international drilling company Boart Longyear (BLY) that will exit the top 100 on December 21 after a big price fall.

The drivers for the Industrials sector are many and varied. There are a number of mining services companies listed on the ASX, but only Monadelphous makes the top 100 list and my list of 13 stocks. If you’ve been following my earlier articles in this series, you may recall that in my review of the Energy sector I chose to reallocate Worley Parsons from Energy to Industrials, but its rating of 2.6 precludes my selection of it at this time.

Only six of the 13 stocks in the table below have a recommendation (less than or equal to 2.5 – remember, the lower, the better) sufficient to warrant my consideration for including them in a high conviction portfolio. The largest, Brambles, which runs an international distribution network of pallets and plastic containers, fails to make my list. So the three biggest stocks by market capitalisation with a sufficiently good rating are: Transurban (TCL), Aurizon (AZJ) and Asciano (AIO).

There is a paper on under ‘Market Updates’ that illustrates my methodology and provides more detail on the statistics I use.

The top stocks

Transurban is an infrastructure company that owns motorways in Australia. Hence, price growth is not usually expected to be particularly strong, but the dividends are quite reasonable at 5.4%. Aurizon is a rail freight company based in Queensland and Asciano is involved in rail and port services. Downer EDI (DOW) is a much smaller company involved in engineering and infrastructure services, but it does have the best rating (1.9) of the 13 stocks in the top 100.

The sector as a whole looked quite promising at the beginning of the year, but it took a beating when the doom and gloom story about China emerged in mid-2012. It has always been my opinion that the China story was massively overdone and the prices of many stocks in this sector have improved markedly in the last few months. These wild price fluctuations have had a major impact on the relative market capitalisations. As a result, it might be worth considering other stocks outside the current biggest three with acceptable ratings.

My current forecast for capital gains for the Industrials sector over the next 12 months is a very respectable 14.5% with a forecast dividend yield of 4.6%.

I would never own an airline for so many reasons and so Qantas is not on my list – even though its rating is quite good (2.3); but SEEK (2.5), an internet employment services company, seems to have some merit.

The recent history of the consensus recommendations for TCL, AZJ, AIO and DOW are shown in Chart 1. TCL’s rating has been deteriorating for much of the time and this trend is a concern. The ratings for AZJ and AIO have been reasonably stable. DOW’s rating has improved strongly, which is why I have added it to my list for consideration.

The wild fluctuations in stock prices have led to the sharp changes in my measure of mispricing – exuberance – shown in Chart 2. I had the sector very underpriced at around -18% in the middle of 2012 and another good buying opportunity arose in mid-November. I currently have the sector priced at about par, which does not in my methodology, imply that one should not buy, but that there is no ‘free kick’ to accompany a buy at this point.

I don’t currently own any of the stocks from this list, but I did once own some TCL. My current holdings are Boart Longyear (BLY), Bradken (BKN), and Emeco (EHL) – three mining services companies in the ASX 200. All three went down sharply with the sector on the China story, but all three are showing promising signs of recovery. If, as I believe, the world will look a lot stronger in coming months, these stocks prices might ride the wave back up.

Ron Bewley is the Executive Director of Woodhall Investment Research.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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