Leading hedge fund manager Ole Andreas Halvorsen of Viking Global Investors bought more stock in industrial companies Deere (DE 0.03%) and Fortive (FTV 0.33%) and elevator and escalator company Otis (OTIS 0.56%) earlier in the year, according to SEC filings.
Halvorsen is a highly successful long/short stock picker and his firm currently manages $44 billion in assets, having notably managed a portfolio that finished flat in 2008, the same year that the S&P 500 index fell nearly 40%.
A quick look at the performance of the three industrial stocks reveals that Fortive has underperformed the S&P 500, while Deere and Otis have outperformed.
That said, should investors, follow Halvorsen and his hedge fund into these stocks now? Let's take a closer look at these three companies.
Let's start with Fortive. The underperformance of this stock is somewhat surprising, as its mix of industrial business gives it cyclical exposure to the improving economy. Moreover, management already hiked full-year adjusted diluted EPS guidance from the range of $2.40-$2.55 given in February to $2.50-$2.60 in April.
Perhaps one reason for the underperformance is because Fortive isn't the easiest company to understand. Around 40% of its revenue comes from its intelligent operating solutions (IOS) segment; the largest business within it is electronic test and measurement company Fluke. As such, the IOS is a play on the growth of automation and digitization and the need to ensure safety and reliability -- not least to meet regulatory requirements in the industrial economy.
Precision technologies (PT) generates 35% of revenue and makes products that help engineers develop new electrical and electronic products. Key customers read like a who's who of the major industrial companies, including GE, Siemens, Apple, Samsung, and Lockheed Martin. Management sees a growth opportunity from its customers developing internet of things (IoT) and automation solutions. Finally, advanced healthcare solutions (AHS) helps hospitals deliver healthcare. Its largest business is an infection prevention business, ASP.
Fortive has powerful tailwinds behind it. The collection of business that CEO Jim Lico has built up over the years generates a 58% gross profit margin and 23% profit margin while converting 18% of revenue into free cash flow (FCF). Lico believes a combination of mid-single-digit percentage revenue growth and margin expansion could lead to $1.6 billion in free cash flow (FCF) in five years -- equivalent to around 6.8% of the company's market cap. That would be an attractive valuation, but a lot can happen in five years.
On balance, Fortive is a very attractive company -- but trading at 27 times estimated 2021 earnings, it's hard to argue the stock is a compelling value right now.
This industrial company can do no wrong in 2021. If it isn't a recovery in key crop prices driving spending on agricultural machinery, it's the ongoing growth in adopting Deere's precision agriculture solutions. If it isn't the housebuilding boom encouraging Deere's construction and forestry equipment sales, it's the promise of a boost in infrastructure spending for Deere's roadbuilding equipment. Meanwhile, Deere's core U.S. agricultural equipment is primed for a replacement cycle due to the advanced age of the fleet.
Deere is firing on all cylinders right now, and Halvorsen's investment has probably paid off handsomely. Still, the question is whether the stock is still a good value now. On balance, I think the answer is yes. Crop prices continue to rise, and industry dynamics look favorable given U.S. soybean exports to China. In addition, Deere's precision agriculture solutions help raise the price of Deere's agriculture equipment, and the tangible improvements they provide to farmers will help keep them loyal to the iconic brand.
It's tough to predict where crop prices will go -- but if you assume they stay where they are now, then Deere's underlying conditions still look favorable.
One of the three new companies created out of the breakup of United Technologies, Otis is the world's leading escalator and elevator company. Given that China is the world's largest end market for escalators and elevators, the country looms large in Otis' end-market prospects.
The second growth opportunity comes from growing the company's higher-margin services revenue through technology that helps it differentiate itself from the competition. For example, Otis continues to equip its service personnel with mobile devices that help identify problems and quickly order replacement parts. Meanwhile, using web-enabled devices on installed Otis equipment allows the company to monitor and respond quickly when servicing remotely. This creates added value to customers, keeps them loyal, and adds to Otis' service revenue -- and services, rather than equipment, tend to generate 80% of Otis' profits.
The company is enjoying the recovery in the global economy, and it upgraded its full-year 2021 sales outlook in April. Management now expects organic new equipment sales to grow 7.5%-8.5%, compared to a previous estimate of 2%-5%, with service sales growing 2%-4%. Overall organic sales are now forecast to grow 4%-6%, compared to a prior estimate of 2%-4%.
Trading at 26 times 2022 earnings estimates, Otis is not a cheap stock. But if you are bullish on China's construction markets in particular, then Otis' long-term growth plans will excite you.
Stocks to buy?
All told, Halvorsen looks to have made good money on Deere and Otis. Deere stock is still attractive if you believe a multi-year expansion in crop prices and agricultural machinery sales is coming, and Otis will attract China bulls. Fortive is a very attractive company, but its valuation suggests it's one for the watch list for now.