Stocks: Boring Is Beautiful

Sleepy industrial sectors like gas and suppliers have given the market big gains this yearand may still ballast a volatile market

Razzle-dazzle and glamour are out. Dullness and dependability are in. That's what the stock market has been telling investors. Some Wall Streeters are betting on solid performances from a few mundane corners of the economy.

Industrial gas, for example. This has nothing to do with the recently hot energy sector. We're not talking natural gas but oxygen, hydrogen, or other gases used for industrial processes.

Industrial gas stocks on the Standard & Poor's 500-stock index are up 31.2% so far this year. That's 12.5 times the performance of the broader S&P 500. (All sector data here come from Standard & Poor's which, like BusinessWeek, is a unit of the McGraw-Hill Companies (MHP).)

Best Bets in Gas Stocks

Top industrial gas stocks include Praxair (PX) and Air Products & Chemicals (APD).

Jefferies Group (JEF) analyst Laurence Alexander likes their smaller rival Airgas (ARG). While Airgas focuses mostly on the U.S., Praxair, a $24.6-billion firm, is the largest and best diversified, with strong operations in Europe. Air Products & Chemicals has a chemicals business, which makes it less of a pure industrial gas stock, Alexander says.

"There is a sense that [industrial gas] is a fairly good defensive industry," Alexander says.

Capital Spending Is Key

Industrial gas is closely tied to the capital spending of industry, which is humming along nicely. There's no sign of a downturn here, Alexander says, but even if there were, it would take a few years to affect industrial gas sales.

Standard & Poor's analysts are neutral on the group overall, but are bullish on Airgas, rating the shares strong buy (see, 8/15/07, "Industrial Gases on the Rise").

Outside industrial gas, another strong sector has been industrial machinery. This is another sector tied closely to capital spending, and both industrial machinery and gases are benefiting from long-term, global trends.

"This has been an industrial decade," says Longbow Research analyst Eli Lustgarten. That's been driven by strong economic growth outside the U.S. Demand for products around the world is booming, and industry has been struggling to keep up.

Also, Lustgarten says, the tight U.S. labor market is encouraging factories to invest in new equipment that relies on fewer workers.

Weak Spots

Of course, there are plenty of weak spots in industrial sectors. In the U.S., Lustgarten notes, end markets have been weak in trucking, autos, housing, and construction, especially residential construction. However, after steep declines, they "look like they're stabilizing to some degree," he says.

Industrial machinery stocks are a diverse group, but they're up 16% for the year. They've stayed strong despite the recent market turmoil. In the past 13 weeks, while the S&P 500 has dropped 3.5%, industrial machinery firms on the index are up 3.3%.

Toolmakers and Industrial Distributors

Illinois Tool Works (ITW), with $15 billion in sales last year, is one of the largest industrial machinery companies. The company, whose stock is up 18% this year, operates 750 different businesses in 49 countries. Other top outfits in the sector include Danaher (DHR), Dover (DOV) and ITT (ITT).

Stocks like Illinois Tool Works, with a "diversified collection of businesses that serves a broader range of end markets" have fared better recently than industrial stocks focused on a narrower market, says Robert McCarthy, an analyst at Robert W. Baird & Co.. "When investors get rattled by near-term macroeconomic returns, they tend to seek safe havens in the more diversified stocks," he says.

For another top-performing sector, look at the often-forgotten "trading companies and distributors." According to S&P, the sector is up 23.5% this year and up 2.1% in the past 13 weeks.

These companies trade and distribute a wide range of products. W.W. Grainger (GWW), the industry leader with $6.1 billion in annual sales, distributes 800,000 products, including adhesives, fasteners, filters, pumps, security equipment, and tools. Its rival, Fastenal (FAST), says it's the nation's largest fastener distributor. MSC Industrial Direct (MSM) is the No. 3 industrial distributor, supplying more than 500,000 products.

All three of these sectors are connected to the industrial sector and thus insulated a bit from the big problem areas in the U.S. stock market: Housing and financial stocks.

Credit Crunch Could Dampen Growth

CIBC World Markets analyst Christopher Glynn notes that things look good for overall industrial activity, but the credit crunch could spill over here, too. Commercial construction, for example—a key driver of industrial activity—may be "insulated by the existing project pipeline" for another six months. But a drop or stop in new construction loans "would clearly change the complexion in these markets."

The credit crunch is probably not having much direct impact on industrial companies now, Baird analyst McCarthy says. However investors are worried that riskier times could prompt business executives to slow down future capital expenditures. "The immediate concern is what [the crisis] does to the corporate equivalent of consumer confidence," McCarthy says.

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