It's been a tough year for the industrial sector, with the COVID-19 pandemic hitting this sector more than most. The companies on this list have seen their near-term earnings potential impaired by the coronavirus, but investors willing to take a long-term perspective will see three stocks with a lot of upside potential. Here's why industrial conglomerate Honeywell International (NYSE:HON), industrial software company PTC Inc. (NASDAQ:PTC), and residential and commercial water treatment company Pentair (NYSE:PNR) are all stocks worth buying.
The company is set to report a horrific set of second-quarter earnings, with management expecting sales to decline more than 15% on a year-over-year basis. The combination of slumps in commercial air traffic, industrial activity, construction, and refining activity is set to hit Honeywell hard.
However, investors should focus on the long term, because despite obvious challenges in commercial aviation, Honeywell has enough growth potential in the rest of its businesses to justify buying the stock at its current valuation.
Honeywell generates nearly a quarter of its revenue from commercial aerospace original equipment and aftermarket -- markets that are probably going to take years to recover to 2019 levels. However, it has other end markets that are poised to grow, such as defense and space (currently 15% of revenue) and its warehouse automation business Intelligrated (a key beneficiary of growth in e-commerce fulfillment).
CEO Darius Adamczyk believes Honeywell's building technologies (around 15% of revenue) have a growth opportunity from an increased focus on healthy buildings due to the pandemic. Meanwhile, demand for Honeywell's advanced materials, refining catalysts and absorbents (via its UOP business), process solutions, and productivity solutions will improve in line with growth in the industrial economy.
In other words, even though the aerospace outlook is mediocre, Honeywell still has a lot of other revenue streams. Currently trading at 18.5 times Wall Street analysts' forecast for earnings in 2021, Honeywell looks like a good value for long-term investors.
This industrial software company has a very exciting future, and it's one that's arguably been enhanced by the COVID-19 pandemic. Indeed, the company is currently seeing strong interest in its augmented reality (AR) and Internet of Things (IoT) solutions. If the pandemic is going to spur investment in automation and interest in digitizing factories, PTC is set to be a key beneficiary.
PTC's core computer-aided design (CAD) sales still contribute around half of its revenue, and management foresees high-single-digit growth from it over the medium term. The really exciting part of PTC's portfolio is its AR and IoT solutions, which are seen as growing at compound annual growth rates of 60% and 26%, respectively, over the medium term.
In a nutshell, PTC is a play on the adoption of so-called fourth-industrial-revolution technologies. The grandiose title simply refers to the process of digitizing factories with the use of web-enabled technologies. Using digital technologies such as "digital twins," companies can digitally simulate a physical asset's performance in order to improve it. Meanwhile, AR allows equipment to be monitored and serviced without a technician even being present.
PTC's management has modeled various scenarios for its medium-term growth rate. The most pessimistic assumption (a recessionary environment) still calls for $700 million in free cash flow in 2024, while the most optimistic calls for $900 million. Those assumptions look very bullish for a stock with a current market cap of just $9.1 billion.
While there's a long way to go before 2024, and the COVID-19 pandemic is an ample demonstration of what could go wrong along the way, a bet on the increasing digitization of factories and production looks like a good one.
Pentair has been transformed into a pure water play in recent years, and it now offers investors a compelling value proposition in a long-term growth market. Having sold its valves-and-controls business to Emerson Electric in 2017 and spun off its electrical business, nVent, in 2018, Pentair is now a company solely focused on residential, industrial, and commercial water treatment. As you can see below, Pentair is attractively priced right now.
Pentair's aquatic systems (residential and commercial pool equipment and accessories) sell into a large installed base of pool owners, and the indication is that Pentair is starting to see an improving sales trend in some of these businesses. For example, an aquatic solutions customer, Pool Corporation (NASDAQ:POOL), is named as being responsible for around 15% of Pentair's net sales in recent years. In a trading update at the end of May, Pool's management told investors that "Consistent with greater pool usage, April and May month-to-date sales have benefited from increased demand for residential pool maintenance supplies, such as chemicals, and for replacement products, such as pool heaters, pumps, cleaners, lights and filters, compared to the same periods in 2019."
While the residential side looks solid, Pentair's commercial and industrial water treatment segments (largely filtration, separation, and flow technologies) are likely to recover more slowly, in line with gradual increases in industrial production and commercial activity. No matter; water treatment is an essential part of industrial activity, and the pandemic is very likely to create a heightened sense of awareness around health issues in commercial pools.
With that in mind, Pentair is attractively priced for a business set to generate solid earnings growth over the long term.