Manufacturing More Than Dividends

11/03/2010 2:00 pm EST

Focus: STOCKS

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

Benjamin Shepherd, associate editor of Personal Finance, likes two multinational manufacturing giants that also pay good dividends.

The recent financial crisis ravaged more than just banks and homebuilders. Manufacturers suffered their fair share of pain as weak demand prompted many businesses to draw down inventories.

But the picture has improved considerably. A robust restocking cycle added to order books and strengthened economic growth. Sales—and, by extension, production—of everything from automobiles to household appliances have been on the rise.

In many instances, this uptick in business flowed straight to the bottom line, as many manufacturers had slashed costs. Industrial manufacturers’ third-quarter results should be some of the best since the recession [began].

Admittedly, easy post-recession comparisons [have] ended for many firms, and contracting debt loads suggest that US consumers are focused on repairing household balance sheets rather than increasing spending.

But the sector’s long-term fundamentals remain sound. Manufacturers should resume previously postponed capital-spending initiatives, because older equipment reduces a firm’s ability to compete.

[Also,] although consumer spending won’t return to pre-recession levels any time soon, households can hold off on replacing worn-out goods [only] for so long.

Growing demand in emerging markets and stronger European [economies] should provide incentive to restart idled production lines.

[Meanwhile,] many industrial names still trade at attractive valuations.

Honeywell International (NYSE: HON) produces everything from jet engines and flight-navigation systems to automation and control systems and specialty materials.

One business line that shows promise focuses on technologies that reduce energy and water consumption—a major growth industry. Honeywell is also a leading producer of aerosols and refrigerants that replace chlorofluorocarbons (CFC, or Freon), a compound that depletes the ozone layer and is banned in many developed nations.

Meanwhile, Honeywell’s aerospace business is staging a strong comeback. The division’s revenue dropped sharply in 2007 and 2008, as demand for small planes plunged. But resurging orders in the US and strong demand in Asia and the Middle East are fueling an earnings recovery.

Yielding 2.8%, HON is a Buy under $47. (It closed slightly above that Tuesday--Editor.)

Defense spending drives the bulk of ITT’s (NYSE: ITT) business, and the stock has sold off sharply as the US winds down operations in Iraq. Cuts to the defense budget are likely, though the stock’s recent nosedive appears overdone. Future spending cuts will probably be better characterized as surgical strikes rather than the slash-and-burn campaign the market appears to expect.

And ITT’s areas of expertise should provide a degree of insulation. The firm produces strategic command-and-control systems, tactical warning and assessment systems, and cutting-edge radio technologies—products that are crucial to supporting our military.

ITT also operates a successful fluid-technology segment that specializes in water and waste-water treatment systems. Demand for water infrastructure and fluid-control solutions has exploded amid increasing urbanization in emerging markets and stricter regulation of pollution.

That provides plenty of opportunity to boost recurring revenue through long-term service contracts.

Buy ITT under $50. (It closed above $47 Tuesday, yielding 2.1%—Editor.)

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