If the economy is so terrible, why are machinery stocks relatively strong?

08/31/2010 3:37 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Oddly enough on a day, August 31, when investors are again feeling nervous about growth, machinery stocks are showing relative strength. Among the standouts Caterpillar (CAT), Joy Global (JOYG), Bucyrus (BUCY), and Deere (DE).

This group has been through a day much like this not so long ago. On August 12 the same stocks were up—with the exception of Caterpillar, which was down slightly. Caterpillar  (CAT) was the catalyst for the strong showing that day by the sector. On the morning of August 12 the company announced that it would triple the production capacity of its U.S. excavator lines and add 500 more employees with the opening of a few plant in Texas. Caterpillar said that plant will be operation in mid-2012.

Now, of course, Caterpillar’s optimism about its business may be completely misguided or wildly early, but it echoes news from other machinery companies: If your customers are other companies with long-lead times between breaking ground on a mine or an airport or a communications network and having them go into use, then you’re actually seeing an increase in business. That’s been the story at a company such as Cummins (CMI) and at Intel (INTC).

Today, August 31, the catalyst looks to be earnings from Joy Global due before the open tomorrow. The thinking among analysts is the company will beat modest expectations for the current quarter and then predict strength for the fourth quarter, which is typically the strongest of the year.

One stock that isn’t in today’s list of leaders but that will be a major beneficiary of this trend is Komatsu (KMTUY.PK), the world’s second largest construction-equipment maker. Like all other Japanese exporters, Komatsu has seen its shares hammered by the ever-climbing yen. A stronger yen threatens to price Japanese products out of markets from cars to cameras. The stock is down a little over 2% today.

But if the yen ever turns around—and it will if and only if the U.S. economy shows signs that it’s headed toward economic recovery rather than a new recession--I think Komatsu becomes a very interesting pick in the machinery sector.

In July the company announced plans to double production in the fiscal year that ends in March 2011 to meet demand from China and Indonesia. Production will climb to 85,000 building and mining machines compared to 44,000 in the previous fiscal year, executive officer Masahiro Uegaki told Bloomberg that month. That projection was about 60% higher than the company’s prediction in April.

In July the company raised its forecast for first half profits—that’s the period from March 31 through the end of September—by 41%.

Typically for a depressed cyclical stock coming off a bottom Komatsu trades at a horrendous 55 times trailing 12-month earnings but at just 12 times projected earnings for the 2012 fiscal year.

If the turnaround the Komatsu is forecasting actually materializes, this is one cheap stock. I’m adding it to Jim’s Watch List today.

The stock is down about 6% from the beginning of the year.

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