This week, we reintroduce our volatility charts and here we highlight the inverse correlation between volatility and valuation. We also touch on GE and the fresh, old claims around its accounting.
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The risks remain in the distributor channel with inventory trends at cycle peaks - electrical, chemical, MRO and Big Box stand out to us. Manufacturers remain in better shape, although A&D, Auto, Chemicals and Semi sectors are carrying excess inventory. Generally, we see channel burn as a risk to short cycle demand into 1Q20, compounded by increasing sell-out weakness. EE/MI stocks with greatest leverage to external channels are 3M, SWK, ROK, RBC, HUBB and ITW; GE and UTX are least exposed.
Folks – I wanted to send you a complete and up to date compilation of our models post-2Q19 results. Our Model Book also includes cheat sheets and bull/bear target price spreads for each company.
We are in the middle of the Atlantic hurricane season, and we can't help but draw a parallel with the economic slowdown and associated China trade conflict that is buffeting industrial demand. Capital spending has flattened out for FY19, and the outlook for the US over the next 6-12 months has significantly deteriorated. Global capex spending remains relatively depressed vs. history, which likely limits 2020 downside risk, and offers continued hope of recovery in a more stable macro backdrop.
We are turning more bearish and so look at the quantitative attributes that tend to drive relative performance during EE/MI corrections. The good news is that we think we are well positioned to outperform through a choppy macro. We note that JCI, ITW and PH are outperforming relative to our expectations, while FTV, DOV and UTX are lagging – these are the three stocks where we see best potential for new money flows post-earnings.
2Q19 played out pretty perfectly on the fundamentals, but positioning was so important this quarter. We believe it is too early for a pro-cyclical trade and we remain significantly below FY20 consensus for ROK, MMM, PH, FAST, GWW and WCC. We see fresh money for DOV, UTX and HUBB out of EPS season.
FY19 earnings took a larger than expected step down, and we believe the lower end of the range looks about right. We believe management’s strategic shift towards a tighter, higher ROIC portfolio with lower financial leverage argues for a higher multiple. But we cannot make that call until we have a better handle on FY20 earnings power.
This feels like a very different environment. Global PMIs are sub-50 – a bullish indicator for Cap Goods stocks – yet trade tensions are ratcheting substantially higher, valuations are too rich and we have yet to see a negative EPS revision cycle in the US. This all argues for a more defensive profile.
RBC 2Q19 results and guidance are weaker than bearish expectations, with 10c miss versus the street and 9c below WRe. The weakness in NA Distribution channel (destocking), NA O&G (upstream), Ag and Comm. Refrigeration led to lowered FY19 guide of $5.50-5.80, with the midpoint 10% below the current consensus/WRe of $6.26/6.29. We expect a similar negative reaction for the stock tomorrow (8/6/19).
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