2017 growth abating in 2018: Restate cautious view
We reiterate our cautious view on the European Capital Goods sector into 2018
Our in-depth analysis suggests that leading indicators, inflation and relative earnings
momentum – the drivers that stimulate and lead the capital goods sector's operating
and share price outperformance – continue to fade. Going into 2018, we still believe
this poses a risk to the sector's relative earnings power and to its near all-time high
valuations (detached from its cyclical roots, in our view). As a consequence, we have
recently downgraded or initiated coverage on cyclical names with a cautious view. With
this note, we downgrade dormakaba to Sell and Atlas Copco to Neutral.
Momentum, reflation, and China growth fading; valuations look detached
We believe PMIs sentiment momentum is fading, meaningful industry verticals and
regions show signs of slowdown (outweighing acceleration in other regions and
segments). In this note we provide incremental evidence on how the commodity-led
reflation trend is losing steam, the China slowdown matters for Capital Goods Europe
and capex recovery trends remain modest. Historically, when leading indicators'
momentum peaks, we have seen c10% sector relative underperformance, especially
when valuations remain rich (the sector's 13x 12 month rolling fwd EV/EBIT valuation is
at a multi-year high, and seems disconnected from fundamentals now).
Record growth factored in despite tightening and signs of economic slowdown
The capital goods sector is implying terminal growth rates of 6% for the sector (4%
average since 2005). Consensus is factoring in a 5% revenue CAGR and margins
reaching previous highs by 2019, which we consider too optimistic. In the long run, we
see many encouraging thematic angles on the sector (artificial intelligence, electric
vehicles, the internet of things, robotics, 3D printing), but for our core coverage
universe consensus appears to be factoring in a 10% EBIT CAGR for 2016-19 vs. our
6% CAGR, which leaves our estimates over 5% below consensus for the same period.
How to position: transformation stories, resilient quality and valuation
We look for transformation stories and attractive valuations (e.g. Alstom, Siemens,
Osram). On a relative basis, and despite valuations, we prefer resilient quality angles
from Legrand and the lagging recovery of Alfa Laval's end markets. We continue to be
cautious on the pro-cyclical expensive names like Kone, Krones, Sandvik, SKF.