Industrials Presentation

1
INDUSTRIALS
Sector Analysis Finance 724/824 April 30, 2002
2
ANALYSIS FRAMEWORK
Sector Overview
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SECTOR MAP
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INDUSTRIALS v. SIM Portfolio v. SP 500
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SECTORS IN SIM PORTFOLIO V. SP INDUSTRIALS
Conglomerates Tyco Services Concord EFS, IMS
Health Building Masco
Double Overweight Services, Double Underweight
Conglomerates Big Bet on Building - Including
Lowes, 12.5 of SIM Portfolio is exposed to
housing NOTHING in Aerospace Defense
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CURRENT HOLDINGS
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DEMAND ANALYSIS
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INTERNAL ISSUES
ACCOUNTING! Aggressive Accounting Investor
Distrust Net effect Caution and
Opportunity.   Goodwill and FASB 142 Net
effect Modest
PROFITS! Example GE earnings decline for
first time since 1994.Revenues Flat Decline
in 2/3rds of GEs businesses.
LACK OF LEADERSHIP Diverse sector needs a
leader.GE is 1/5th of capitalization and clear
sector leader. Will a GE recovery lift the entire
sector?Who will be New Market Leaders?
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INTERNAL ISSUES INDUSTRY-SPECIFIC OUTLOOKS
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EXTERNAL FACTORS

• Economic recovery?
• Flight to quality
• Comfort in old economy stocks/products during
  volatile times
• Look for continued migration to familiarity of
  industrials in near term
• Mitigated by accounting fears
• Where IS quality when earnings cant be trusted.
  GE and TYC today. CD and WMI before.

Impact -
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EXTERNAL FACTORS

• Government/Foreign
• Trade Wars and Steel Tariffs
• Short term boost to U.S. producers outweighed by
  negative foreign response
• War on Terror and Iraq
• Markets dont like war VOLATILITY
• Opportunities in Defense Sector
• Energy Costs Rising gt Producers
• No Alaska NWR drilling
• U.S.-Israeli ties tenuous relationship
  w/oil-producing allies in Middle East
• Instability in Venezuela (4 of World Supply)

Impact - ?? -
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EXTERNAL FACTORS
Impact - ??

• Key Indicators
• Interest rates
• Rise will be slower than initially expected.
• Fed has never raised rates with unemployment
  rising.
• Consumer spending
• Expected 1.5 in 2002, 2.6 in 2003
• Travel down 15 from last year
• Post 9-11 jitters remain not back to business
  as usual
• Housing has been strong throughout recession
• Expected to hold steady but some downside risk

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SECTOR FINANCIALS OVERVIEW

• Bullish Signs
• Consistent Growth
• Expected to outperform SP in 2002.
• DuPont Analysis gives a Buy signal on cyclical
  bottom
• Bearish Signs
• Leverage Issues Ratios have slipped over past 5
  years.
• Accounting Surprises

Market Capitalization 431 Billion Industrials
EPS 1.62002 Estimated EPS
1.92003 Estimated EPS 2.3 Industrials P/E
24.92002 Estimated P/E 24.02002
Estimated P/E 20.2 Industrials
Dividend Yield 1.45
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FINANCIALS EARNINGS

• Consistent Top and Bottom Line Growth
• Price supported by earnings
• Trading at 1999 price

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FINANCIALS EARNINGS

• Expected to outperform the SP in 2002

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FINANCIALS DuPont Analysis
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FINANCIALS
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FINANCIALS
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FINANCIALS SUMMARY

• Bullish Signs
• Consistent Growth, Earnings and Dividends
• Expected to out-grow SP in 2002.
• DuPont Analysis gives a Buy signal on cyclical
  bottom
• Bearish Signs
• Leverage Issues Ratios have slipped over past 5
  years.
• Tremendous ROE Growth has boosted sector
  valuations, can it continue?

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VALUATION Technical Analysis

• Horizontal pattern since 1999
• Support at 36
• Resistance at 47
• Currently at 37
• Bottom of cycle, Room to grow

YTD
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VALUATION Price Multiples v. SP

• In solid economic times, Industrials trade at 10
  P/E premium to SP 500
• Industrials are currently trading at 6 below SP
  500 P/E!

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VALUATION LIFE CYCLE ANALYSIS

• Earnings Expectations Life Cycle Low Side
• Trend of downward revisions to earnings estimates
• Mixed surprise earnings results

High
Rising
Falling

• VALUE!

Low
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EARNINGS SURPRISES REVISIONS
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Industrials vs. SP 500Price valuation

• Trailing PE has been in line with SP
• Year forward PE is slightly higher
• Significant growth trend compared to SP

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Industrials vs. SP 500Returns

• Earnings have been in line with SP
• Total returns have outperformed SP by 10
• Estimated EPS F12M are 15 higher compared to SP

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Industrials vs. SP 500 Sectors

• Growth supported by earnings
• One of the strongest sectors following a
  recession
• Need a strong position for the recovery period

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Valuation Sub-Sector Performance

• Changing of the guard
• Conglomerates are down
• Areo / Defense, Industrial Machinery, and Data
  Processing are Up

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RECOMMENDATIONS

• Trends
• Value Sector
• Cyclical Recovery (Our Analysis We are at the
  Bottom)
• New Leadership of Defense

• Opportunities
• Shift into defense and defense suppliers
• Look for relative value in services pre-recovery
• Find companies with balance sheet leadership
• Risks
• Market questioning conglomerates
• Supply issues in steel energy
• Low Beta Sector, but widely exposed to macro
  trends

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WATCHLIST

• Value
• General Electric (GE)
• Boeing (BA)
• First Data Corporation (FDC)
• John Deere (DE)
• Cyclical Recovery
• Waste Management (WMI)
• Cendant (CD)
• ADP (ADP) and Paychex (PAYX)
• BISYS Group (BSG)
• Aerospace Defense
• Boeing (BA)
• Raytheon (RTN)
• Suppliers United Technologies (UTX)
• More To Be Determinated

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ECONOMIC TRENDS

• Economy appears to be heating up despite high
  unemployment