4. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Fall Transaction Review
• JEC sold because of their exposure to a weakening subsector.
• ETN was trimmed because of their poor stock performance and
negative outlook.
• PCP was purchased because of their strong position in a strong sub-
sector.
• PRLB was purchased due to their position in a rapidly growing sub-
sector (3D Printing) as well as their great margins.
Transactions
Sold 85 shares of JEC
Trimmed 57 shares of ETN
Bought 37 shares of PCP
Bought 62 shares of PRLB
5. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Current Allocation
Company Ticker Holding Value
Precision Castparts Corp. PCP $7,851
Eaton Corp. PLC ETN $3,669
Cummins Inc. CMI $5,498
Proto Labs Inc. PRLB $4,354
Honeywell International
Inc.
HON $8,752
3M Co. MMM $8,339
Total $38,463
Need to Free Up .5%= $1,691
PCP
20%
ETN
10%
CMI
14%
PRLB
11%
HON
23%
MMM
22%
ALLOCATION
8. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Industrials Sector
• Comprised of companies that engage in the
production of products used in construction and
manufacturing.
• Includes machinery, materials, aerospace and defense,
industrialized shipping, and engineering services.
Industrials Sector S&P 500
YTD Return -1.79% +.10%
Average P/E 17.87 18.26
Mean Dividend 2.09% 2.00%
11. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Aerospace and Defense Outlook
RPK (Trillions) = revenue passenger kilometers or distance traveled by revenue producing customers
13. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Aerospace and Defense
• Other Trends:
• Strong growing market expected to continue over next 30 years
• Increased demand for efficiency in aircrafts
• Airlines will need 36,800 new planes from 2013 to 2033
• Defense spending is flat volatile
• Strongest growth is in emerging markets
• Boeing and Airbus have substantial backlogs
21. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Critical Factors and Catalysts
• Critical Factors
• Great Management: Dave Cote (+)
• HOS Gold and HUE initiatives (+)
• $10 billion in M&A over next 5 years (+)
• Positive long-term outlook for aerospace (+)
• Increased demand for efficiency in aerospace (+)
• Slowing growth in China and slow growth in Europe (-)
• Urbanization, population growth, and infrastructure development in
emerging markets (+)
• Strengthening dollar (-)
• Commercial construction picking up (+)
• Catalysts
• Share buyback (+)
• Dividends growing faster than earnings (+/-)
22. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• New product development incorporates eco-
efficiency criteria.
• Many of their products focus on high efficiency.
• High efficiency focused aerospace products.
• New environmentally friendly refrigerants.
23. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Why we bought them (Spring 2014):
• Could not find pitch on the drive so difficult to say if anything
has changed.
• We assume they liked the firm’s growth strategy as well as their
exposure to industries with positive outlooks.
• What has changed?
• Portfolio goals (beta and market cap)
• Double digit earnings growth expected over the next 5 years.
• HOS Gold
• HUE
• Recommendation: HOLD
24. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Precision Castparts Corp. (PCP)
Key Metrics
Latest Closing Price $212.18
MKT Cap $30.08B
Beta (β) 1.16
P/E 16.42
Dividend Yield 0.06%
Debt/Equity 35.10%
Return YTD -12.74%
Return since purchase -5.90%
Precision Castparts Corp. has been around for over 60 years
and has grown into a worldwide, diversified manufacturer
of complex metal components and products such as:
• Investment Castings
• Forged Components
• Aerostructures
• Aerospace
27. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Revenue
• Revenues in 2014 were increased to $9,616M
• 15% increase from $8,361M in 2013
• 2014 acquisitions account for $1.2B in extra sales
• Aerospace accounts for 68% of total sales in 2014
Earnings/Share
Period Consensus Actual Surprise
Q4 2014 $3.084 $3.09 +0.19%
Q3 $3.321 $3.24 -2.44%
Q2 $3.354 $3.32 -1.01%
Q1 $3.198 $3.27 +2.25%
30. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Catalysts/Critical Factors
Critical Factors:
• Aerospace industry is continuing to grow (+)
• Strong acquisition of 18 businesses since 2013 (+)
• Highly cyclical aerospace/power generation markets (-)
• Subject to contract revision by customers (-)
Catalysts:
• $7.3B in backlog for all revenue segments (+/-)
• Roughly 82% expected to be filled in 2015
• $1B expansion to the share repurchase program (+)
31. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• Precision Castparts handles issues with “conflict
materials”
• Tin, Tantalum, & Gold have large reserves in the DRC
• Review and understand the composition of all inputs
• Attempting to obtain ISO 14001 certification
• Framework for an environmental management system
32. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Why we bought them (Fall 2014):
• Strong outlook in the aerospace and defense industries
• Solid acquisition history/vertical integration
• What has changed?
• Misaligned with fund’s goals (large cap of $30.08B)
• Recommendation: HOLD
33. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Cummins Inc (NYSE: CMI)
• Cummins is a global power leader that
designs, manufactures, sells and services
diesel engines and related technology around
the world. Cummins serves its customers
through its network of 600 company-owned
and independent distributor facilities and
more than 7,200 dealer locations in over 190
countries and territories.
Key Metrics
Price $137.46
Market Cap $25.01B
Beta 1.35
P/E 15.76
Dividend Yield 2.28%
Return YTD -3.46%
Return Since
Purchase
47.37%
34. CMI vs S&P 500 Industrials
CMI US Equity
S5INDU Index
35. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Business Segment Overview
• Engine Business
– Heavy and medium duty truck, bus, light duty automotive
– Agricultural, construction, mining, marine, oil and gas, military
equipment
• Power Generation Business
– Power generation systems, components and services, auxiliary power
• Components Business
– Filtration, emission solutions, fuel systems
• Distribution Business
– Global distribution strategy and channel management
41. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• Eight years and counting: Named one of the
World’s Most Ethical Companies
• No. 11 on “100 Best Corporate Citizens List”
by Corporate Responsibility Magazine
• Raising awareness about Waste Management
in La Pila, Mexico
• Focus on fuel efficiency in new product lines
• CSR included as one of six company core
values
42. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Purchased: October 2012
– Continued economic recovery
– Bullish outlook
• What’s Changed
– Cyclical industry
– Expansionary phase
– Current positive truck production outlook
43. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Cummins: The Bottom Line
• Critical Factors
– Strong North American truck demand for 2015 (+)
– Aggressive vertical integration in distribution segment (+)
– Weak Power Generation segment (-)
• Catalysts
– High freight rates and low diesel prices to expand fleet capacity
and increase profitability (+)
– Exposure to weak emerging markets in China and Brazil (-)
– Cyclical nature of commercial vehicle sales (-)
• Recommendation: Hold
44. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Proto Labs Inc. (PRLB)
Was founded in 1999 as The ProtoMold Company
and has become the world’s fastest source for
custom prototyping for low- to mid-volume parts
• fineline®
• Additive Manufacturing
• firstcut®
• CNC Machining
• protomold®
• Injection Molding
Key Metrics
Latest Closing Price $70.22
MKT Cap $1.82B
Beta (β) .75
P/E 43.89
Dividend Yield 0%
Debt/Equity .06%
Return YTD 4.23%
Return since purchase 11.32%
47. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Revenue
• Revenue in 2014 was $209.6M
• 28.5% increase from $163.1M in 2013
• Record quarterly revenue growth in all three geographies
• 23% year over year in America
• 10% in Europe
• 25% in Japan
Earnings/Share
Period Consensus Actual Surprise
Q4 2014 $0.423 $0.43 +1.65%
Q3 $0.465 $0.44 -5.38%
Q2 $0.422 $0.45 +6.64%
Q1 $0.389 $0.41 +5.40%
50. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Catalysts/Critical Factors
Critical Factors:
• Acquisition of fineline in April 2014 (+)
• Expansion into the 3D printing market (+)
• New proprietary technology allowing for fast turnaround times (+)
• Larger competitors are able to obtain market share (-)
Catalysts:
• Revenue has grown in all geographical locations (+)
• Strengthening dollar (-)
• fineline accounted for 4.49% of revenues in 2014 (+)
51. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• Proto Labs handles issues with “conflict materials”
• Tin, Tantalum, & Gold have large reserves in the DRC
• Review and understand the composition of all inputs
• High supply chain expectations
• Expect suppliers to establish a due diligence program
• Compliance with the Conflict Free Smelter (CFS) Program
52. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Why we bought them (Fall 2014):
• Acquisition of fineline allowed them to enter 3D printing market
• Emerging market with significant future growth
• Industry leader due to quick quoting and turnaround times
• What has changed?
• Beta is misaligned with portfolio’s goals (β = .75)
• Recommendation: HOLD
53. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
3M (MMM)
• Globally diversified technology company (they do everything)
• 5 Product Segments
• Industrials (34%)
• Safety and graphics (18%)
• Electronics and Energy (17.6%)
• Health Care (17.5%)
• Consumer (14.2%)
Key Metrics
Latest Closing Price $163.50
MKT Cap $103.9B
Beta (β) 1.07
Dividend Yield 2.09%
Debt/Equity 52.02%
Return YTD 1.94%
Return since purchase 61.45%
59. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Critical Factors and Catalysts
• Critical Factors
• Increased M&A activity ($1-2B a year) (+)
• Divesting lower margin business (+)
• Reorganizing segments to increase synergies (+)
• Continuing heavy emphasis on R&D (+)
• Heavy exchange rate risk (-)
• Slowing foreign growth (-)
• Catalysts
• Share repurchase program (+)
60. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• “3M has long held the belief that
reputation depends not solely
on financial performance but
also on the way we run our
business.”
• One of the first manufacturing
companies to address
environmental issues (1975).
61. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Why we bought them (Fall 2011):
• Could not find specific reasons.
• They were and are a great company.
• What has changed?
• Portfolio goals (beta and market cap)
• Strong dollar
• Recommendation: SELL
62. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Eaton Corp PLC (NYSE: ETN)
• Eaton provides power-management
solutions to diversified industrial customers,
including electrical systems, hydraulics
components, aerospace fuel systems, and
truck and auto powertrain systems. The
company sells to both original equipment
manufacturers and aftermarket customers
and generates more than 50% of its sales
outside the United States.
Key Metrics
Price $66.70
Market Cap $31.18B
Beta 1.48
P/E 14.19
Dividend Yield 3.30%
Return YTD 1.57%
Return Since
Purchase
-8.37%
63. ETN vs S&P Industrials
ETN US Equity
S5INDU Index
64. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Business Segment Overview
• Electrical Business
– Power distribution and control products, circuit breakers, LED
lighting, operator interface hardware and software, motor control
products, etc.
• Fluid Power Business
– Fluid power connectors, hydraulic pumps, motors, power steering
units, filtration products, etc.
• Automotive Business
– Valvetrain systems, intake and exhaust valves, superchargers,
transmission dampers, engine sensors and controls, etc.
• Aerospace Business
– Hydraulic systems, fuel and inerting systems, motion control, engine
solutions
68. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Cooper Acquisition
• Global manufacturer of electrical products and systems
• $13.19B ($6.5B Cash, $6.6B Stock) in November 2012
• Cumulative Cost Savings Targets
– 2015: $280M
– 2016: $325M (Peak)
• Little progress narrowing gap between margins and the
S&P Industrials Index
71. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Corporate Social Responsibility
• China:
– Recognized for the “Golden Bee CSR Report
Evergreen Award”
– Ranked in the top ten of the “2013 China CSR
Honor Roll” Top 100 Enterprises
• “Sustainability not viewed as an autonomous
program or initiative. It’s how we do business.
Doing business right is a part of the central
vision.”
72. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
“The Stein”
• Purchased: May 2014
– Opportunities for growth due to heavy exposure
to electrical equipment
• Revised and Trimmed: October 2014
– Growing exposure to international markets in
China and Brazil have caused operational growth
to suffer
– Management consistently revising earnings
73. Fall 2014 Review
Sector Overview
Company Overviews
Proposals
Eaton: The Bottom Line
• Critical Factors
– Vehicle Segment: North American truck market (+)
– Strong US LED lighting products sales (+)
– International electrical sales outlook (-)
• Catalysts
– High customer switching costs (+)
– High hopes for increased credit rating (-)
– Weak European electricals and utilities (-)
• Recommendation: Sell
-Distribution segment steadily increasing – vertically integrating through acquisitions (7 in 2014 and 3 more planned for 2015)
-Ongoing distributor acquisition caused Dist. Rev to jump 38%
*Non-Segment Items: includes intersegment sales and profit in inventory eliminations and unallocated corporate expenses.
-Divestitures, legal matters, sale of assets/liabilities in light duty filtration business (Components Segment), flood damage recoveries.
*Continued strength in US and concerns in China/Brazil due to weak economics conditions and low demand
*Slightly increased ST and LT liabilities due to company’s distributor acquisition strategy
*Healthy financial position to cover any debt payments
*2012 Q3 dip: significantly weakened demand in North American heavy duty truck market due to industry wide production rate cuts (that were anticipated) and slower than expected new order rates
*2013 Q3 dip: Declined engine business revenues due to weakness in global mining and power generation demand.
-Power generation demand: weak international market demand in India, Australia and Europe offsetting the growth in China and Brazil
-Strong N.A. truck demand – 2014 grew 20% - industry truck production up 10%. Highest backlog orders since 2006. New product lines implementing in 2015 – ISG heavy duty engine, QSK95 engine, 2016 Nissan Titan (light duty truck market)
-Distribution segment: 7 acquisitions in ‘14, 3 more planned for ‘15. Company focus on reducing quality costs – improvement of product quality and customer service. Even in the eyes of the most demanding customers expect that quality costs will be reduced in ‘15.
-Power Generation: decreased demand from emerging market customers and lower oil/gas industry – down 23% YoY. To be offset by truck market. Heavily due to increased emissions regulations.
-Diesel prices down 27% YoY, which fuel represents 35-40% of truckers’ costs. Diesel forward contracts indicate prices will remain at or below $3.02/gallon for next 2 years. 98.5% fleet utilization close to record high.
-Weak Brazil construction forecasted to decline truck production forecast an additional 15%. China slow infrastructure/construction spending – down 7% YoY due to new NS4 on-highway emission standards.
-Sensitive to the slowing manufacturing sector and consumer and industrial demand. This could put 2H orders at risk for cancellations. ISM dropped past four months due to slow global growth and strengthening USD (hurting exports).
New proprietary processes allowing for fast turnaround times
Customers upload 3D CAD design to website
Software analyzes the manufacturability of the product
Returns the firm a price based on:
Input materials
Quantity
Process
$482 million in income 6 months 2014
*2012 Cooper acquisition
*Past 2 years: $250M of acquisition related charges
-This could be tied to weaker performance from non-Cooper assets compared with the peer group
-or signal that the company is using Cooper savings to support R&D initiatives)
-Vehicle segment: truck market drove sales up 8% organic growth Q4 2014.
-LED lighting products make up 50% of electrical sales (which is 30% of total rev). Large exposure to both commercial and residential construction (strong expansion in US) could be bright for ETN.
-International: weak construction in China, low oil and gas spending, and low European utility demand giving negative outlook for China, Russia, Brazil, and Europe.
-International sales make up roughly 50% of ETN’s total revenues.
-2014 organic growth of 3-4% is projected to be offset by a 4% decline due to currency devaluations.
-Switching costs – even if a competitor introduced a more compelling technology than ETN’s, the significant costs of changing aircraft design and engineering would make switching away from them uneconomical.
-Distributors prefer to limit number of vendors, makes its difficult for smaller scale electrical manufacturers to have similar scale advantages as ETN. Cooper acquisition strengthens this.
-Credit Rating: since Cooper acquisition ETN has signaled desire to return to an A credit rating. Stock has lagged behind both S&P and S&P Industrials since the announcement deal.
-ETN has launched incentive program to boost EPS, cash flow and total shareholder returns (could be a sign of weakness – hurting chances of getting credit rating increased)
-Consensus expectations (even after accounting for its debt reduction plans) indicate that it may fall short of targets for credit metrics that Fitch and S&P factor into its A- and BBB+ ratings.
-Weak Europe: Combination of over-capacity and weak demand – power prices remain too soft to support construction in most Euro power plants.
