Three Manufacturing Stocks Grind Out Good Returns: John Dorfman

Manufacturing has been one of the main drivers of the U.S. economic recovery. That engine seems in danger of stalling.

The industrial production index from the Federal Reserve Board advanced 0.1 percent in June, down from a robust 1.3 percent in May. July figures haven’t yet been released.

Another widely watched gauge is an index of manufacturing activity issued by the Institute for Supply Management. The indicator, called the PMI Index, dropped to 55.5 in July from 56.2 in June.

These two indicators are among those that make many investors worry about a possible double-dip recession. My view is more optimistic: I believe that U.S. manufacturing will reaccelerate later this year.

One reason these figures don’t shake my confidence too much is that I’m old. Having lived through nasty recessions in the early 1970s and 1980s, I can testify that recoveries are rarely neat and smooth.

Think back (if you, too, are old enough) to the recession that raged during Ronald Reagan’s first term as president. Unemployment in late 1982 hit 10.8 percent.

The PMI index hit a record low of 29.4 in May 1980. Then it rose fairly steadily, to 69.9 by December 1983. The gauge weakened and dipped below 50 -- indicating contraction -- from February through September of 1985. Yet it revived, and today we remember the second half of the 1980s as a boom time.

Stay Calm

In short, it’s easy to panic based on a few months of negative readings in a couple of benchmarks. One key to successful investing is separating noise from underlying trends.

Economic data always send mixed signals. As my mentor David Dreman said, indicators often resemble a traffic light that flashes red, green and yellow simultaneously.

At the moment, I am impressed by the profit reports coming out of many large and mid-sized companies. Rising profits usually presage improvement in other areas such as employment.

Hidden in the July PMI report was some good news. The portion dealing with employment showed a reading of 58.6, up from 57.8 in June.

Manufacturing payrolls rose by 36,000 in July, according to Labor Department data released Friday. The figure exceeds the median forecast of a 13,000 increase made by economists surveyed by Bloomberg.

Here are three manufacturing stocks that I think could hold their own in a listless economy and perform quite well if growth picks up.

Honeywell International Inc. of Morris Township, New Jersey, is one candidate. You may well have a Honeywell thermostat in your home. The company also makes aircraft engines, auto products, advanced materials and other products.

Tangerine Effect

Honeywell stock sells for about $43, less than it fetched almost a decade ago when it ended 2000 at about $47. The company seems to have lost some of its spirit after unsuccessful attempts a decade ago to sell itself, first to United Technologies Corp. and then to General Electric Co.

For investors, Honeywell has one attribute that might be quite lucrative: It is a tangerine. By that I mean that it consists of many discreet segments, which could easily be separated, spun off or sold. It is a financial engineer’s dream.

Meanwhile, Honeywell’s status quo isn’t too shabby. It earned a 27 percent return on equity in 2009. The stock sells for one times revenue and 13 times earnings.

Force Protection Inc., with headquarters in Ladson, South Carolina, makes blast-resistant vehicles used by the military and some law enforcement agencies.

Remaining in Afghanistan

Force Protection has a beautiful, debt-free balance sheet. Its stock sells for seven times earnings, less than book value (assets minus liabilities per share) and 0.3 times revenue. That is extremely cheap. Presumably investors think the company’s earnings will drop sharply when the U.S. leaves Iraq and Afghanistan. I believe that U.S. troops will stay in Afghanistan for quite a while, and there will unfortunately be other hot spots in the future.

Investors may also recoil from the company’s history of losses: It reported losses from 1997 through 2005. Since then, the company has posted a profit each year.

I’ll close with Curtiss-Wright Corp., based in Parsippany, New Jersey, which manufactures parts for the aerospace and energy industries as well as precision metal work.

The “Wright” in the company’s name harks back to the Wright brothers, who made their historic first flight in 1903. The Wright brothers’ association with a predecessor company was fairly brief. More important in the company’s history was Glenn Curtiss, another early aviation pioneer.

Last year 58 percent of its sales were to civilian customers while 42 percent were military related. The company has averaged 9 percent earnings growth and 14 percent sales growth over the past five years. I think the stock is attractively priced at 14 times earnings and 0.8 times revenue.

Disclosure note: I have no long or short positions in the stocks discussed in this week’s column, personally or for clients.

(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

To contact the writer of this column: John Dorfman at jdorfman@thunderstormcapital.com.

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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