Near-Term View Bleak for Diversified Operations Industry

Payal Jalan

22 January 2020 at 8:21 am

The Zacks Diversified Operations industry includes companies that operate in various end-markets like oil & gas, industrial, aviation, technology, finance, healthcare and transportation among others. Such companies manufacture and provide equipment, solutions and related services to a vast customer base.

In addition, there are a few companies that provide their services in the agriculture, marine and telecommunications markets and are also engaged in providing environmental and safety solutions.

Here are the industry's three major themes:

Exposure in multiple end markets is a boon for industry players. Rise in air travel globally, robust demand from the defense and governmental markets, improved activities in the oil & gas market, infrastructure development, changes in tax policies and others are tailwinds supporting growth. Honeywell International (HON) is one such company that is gaining extensively from defense, commercial aerospace and aerospace aftermarket businesses. Its Aerospace business segment accounted for 39% of the company's revenues in the third quarter of 2019. In addition, acquisitions play a key role in boosting growth opportunities. For instance, Danaher Corporation (DHR) is set to acquire General Electric Company's (GE) BioPharma business for strengthening its life sciences business.
Innovation is a priority for industry players as it helps in tapping demand from existing and new customers. However, these activities often make the players more leveraged. Of late, the companies are dealing with the adverse impact of trade tiffs between the United States and other nations, especially China. The issue had an adverse impact on corporate margins. Also, increasing geopolitical tensions, Brexit, inflationary pressure, rising freight charges, scarcity of skilled workforce and unfavorable movement in foreign currencies are adding to the woes. Growth projection of the global economy was lowered by 10 basis points (bps) to 3.3% for 2020 and by 20 bps to 3.4% for 2021 by the International Monetary Fund in January.
Diversification is usually a boon, as profits in one or more businesses can make up for losses incurred in others. However, the same can be detrimental if not handled properly. Conglomerate 3M Company (MMM) divested its communication markets business in 2018. It also sold its gas and flame detection business in August 2019 and advanced-ballistic protection business in January 2020. Also, it will divest its drug delivery business in the first half of 2020. Another player United Technologies Corporation (UTX) will divide its businesses into three independent companies — United Technologies, Otis and Carrier. It expects the move to help it create more customized solutions for customers and create greater shareholder value. Also, industrial giant General Electric split its power business into two to address the prevailing headwinds. It is also working on lowering its exposure in finance-related operations and has already divested its transportation business. It will divest the BioPharma business in the first quarter of 2020.

Zacks Industry Rank Suggests Weak Prospects

The Zacks Diversified Operations industry is a 23-stock group within the broader Zacks Conglomerates sector. The industry currently carries a Zacks Industry Rank #182, which places it in the bottom 29% of more than 250 Zacks industries.

The group's Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry's positioning in the bottom 50% of the Zacks-ranked industries is a result of bleak earnings prospects for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's earnings growth potential. Over the past year, the industry's earnings estimates have decreased 7.6% for 2020.

We will present a few stocks that you may consider for your portfolio. But it's worth taking a look at the industry's shareholder returns and current valuation first.

Industry Outperforms S&P 500

The Zacks Diversified Operations industry's performance has been better than the S&P 500 over the trailing 12 months. While the stocks in this industry have collectively increased 26.7%, the S&P 500 has gained 25.4%.

Past Year Price Performance

Diversified Operations Industry's Valuation

EV/EBITDA ratio is commonly used for valuing companies with diversified operations.

The industry's forward 12-month EV/EBITDA ratio is 26.85. This multiple is way above the S&P 500's forward 12-month EV/EBITDA ratio of 12.66.

Over the past five years, the industry has traded at the highest level of 81.18X forward 12-month EV/EBITDA and lowest level of 17.86X. The median level, over the same period, was 22.03X.

Industry's EV/EBITDA Ratio (Forward 12-Month) Versus S&P 500

Bottom Line

Business opportunities seem impressive for the Diversified Operations industry as many conglomerates are gaining from improved demand across various end-markets served, favorable governmental policies and others. However, prevalent problems — both on macro and micro levels — have fogged up near-term prospects of the industry.

The majority of the stocks within this industry currently carry a Zacks Rank #3 (Hold) or 4 (Sell). Nonetheless, we present four stocks, with a Zacks Rank #2 (Buy), which investors might be interested in.

A brief discussion on the chosen stocks is provided below.

Crane Co. (CR): Shares of this Stamford, CT-based company have increased 10.3% in the past year. The stock currently carries a Zacks Rank #2.

You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

In the past 60 days, the Zacks Consensus Estimate for the company's earnings per share remained unchanged for 2020. On a year-over-year basis, this estimate suggests growth of 6.4%.

Price and Consensus: CR

China Merchants Port Holdings Co., Ltd. (CMHHY): Shares of this Hong Kong-based company have decreased 1.1% in the trailing 12 months. The stock currently carries a Zacks Rank #2.

In the past 60 days, the Zacks Consensus Estimate for the company's earnings per share increased 2.2% for 2020.

Price: CMHHY

Hitachi, Ltd. (HTHIY): Based in Japan, shares of this company have surged 34.7% in the trailing 12 months. The stock currently carries a Zacks #2.

In the past 60 days, the Zacks Consensus Estimate for the company's earnings decreased 28% for fiscal 2019 (ending March 2020). On a year-over-year basis, the estimate for fiscal 2019 suggests growth of 41.2%.

Price and Consensus: HTHIY

Barloworld Limited (BRRAY): This South Africa-based company currently carries a Zacks Rank #2. In the past year, the stock has decreased nearly 21.5%.

In the past 60 days, the Zacks Consensus Estimate for the company's earnings per share has moved 4.3% north for fiscal 2020 (ending September 2020).

Price and Consensus: BRRAY

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