Jubak's Journal
Manufacturing is back: 3 winners                                            6-04-04

Paccar, Middleby and Rogers may not be giants, but they’re well-positioned for the rebound and strong enough to handle the rising cost of materials.

By Jim Jubak

Manufacturing is storming back just in time, which is not to be confused with just-in-time manufacturing.

Don’t see it yet in your neighborhood or town? Well, let me provide you some of the numbers that support manufacturing’s recovery before sharing with you my favorite stocks and companies that I think will benefit the most by the upturn. According to the Institute for Supply Management’s purchasing managers survey:

Norbert Ore, chair of the ISM's survey committee, summed up the May numbers like this: “2004 is shaping up as one of the better years for manufacturing. Many respondents indicate that order backlogs are growing for the first time in several years.”

These numbers are backed up by the April survey of factory orders compiled by the U.S. Department of Commerce. The monthly survey showed a small drop in estimated factory orders for April of 1.7%, but I don’t worry too much about the volatile month-to-month readings. The longer trend is still strongly upward with estimated factory orders in April running a solid 13% above last year’s levels.

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The inventory-to-sales ratio, which measures how much stuff companies have on the shelves to sell in the future versus the level of current sales now looks like it might have bottomed at 1.23 in March, a historic low. The rebuilding of low current inventories would be another plus for manufacturers.

Hefty prices for materials
There is one fly in the ointment, however. The ISM survey reports that companies are experiencing hefty price increases for raw materials, especially for energy. And although companies also reported rising prices for their own products as price increases start to stick, the rate of increase in the cost of raw material inputs is outpacing the ability to raise prices on manufactured output.

This isn’t just a U.S. phenomenon, either: The J.P. Morgan Global Report on Manufacturing, which surveys purchasing managers around the world, reported that average input prices increased for a ninth consecutive month in May and increased at a faster rate than in April.

That combination -- strong positive trend but with potential danger -- determines my approach to the manufacturing sector. I want to find companies riding the manufacturing growth trend, but I want them built to minimize the dangers of inflation in raw materials, especially energy costs. My three choices:


A bet on growth in consumer electronics
Rogers, headquartered in Rogers, Conn., specializes in the polymers and foams that form the backbone of printed circuit boards, chip packages and keyboards. And thanks to its position as a supplier to multiple players in an industry, by buying Rogers you’re betting on continued growth in consumer electronics without having to pick winners and losers. Among its customers are Nokia (NOK, news, msgs), Motorola (MOT, news, msgs), Ericsson (ERICY, news, msgs) and Siemens (SI, news, msgs).



Net sales climbed by 14% in the first quarter of 2004 from a year earlier, paced by 18% growth in the printed circuit materials business that accounts for 46% of company revenue. Growth in that segment, in turn, is being driven by increased sales to the direct broadcast satellite, wireless infrastructure and cellular handset industries. Pretty good growth opportunities there, I’d say. Analysts see earnings per share growing by 82% in 2004, and the stock trades at a price-to-earnings ratio of just 21.3 on those projected earnings.

In addition, as you might expect from a company that’s been around since 1832, Rogers is a very conservatively run company, and that takes a lot of the risk out of high raw materials costs and rising interest rates. For example, Rogers’ margin was relatively flat last quarter as it continued to absorb the costs of moving some production to China and Illinois. Management estimates those moves cost the company about 1 percentage point in margin in the quarter. That cost, however, is actually an investment in future lower costs and improved margins. (Note that margins didn’t actually fall while Rogers absorbed this cost. How do they do that? One answer: inventory turns. The company increased the number of times it sold and replenished its inventory of finished products to 10 times in the quarter from 8.4 times. Less time on the shelf equals higher margins.)

The company’s balance sheet shows $34.5 million in cash and short-term investments and no debt. Good position for a company to be in if interest rates are headed up. Investors like the stock; it’s up 39% so far this year.

Middleby wins because restaurants are expanding
Middleby, on the other hand, makes and services cooking and warming equipment for all kinds of restaurants, from fast food to full service to hotel. After two slow years, Elgin, Ill.-based Middleby is on a roll. Existing customers are picking up their spending: Revenue grew by 11% in the first quarter of 2004 from the same period in 2003. The stock is up more than 50% so far this year.



The key to that growth is a pipeline of new products which accounted for about 50% of revenue in the quarter. These products cut energy consumption in customer kitchens, not a bad selling point at the moment, and they speed up cooking time by about 25%. With seven new product lines planned, the momentum is likely to continue. Analysts are projecting 31% growth in earnings per share this year and 19% in 2005. Middleby trades at 23.9 times projected 2004 earnings per share.

But Middleby’s customers aren’t the only ones who can expect cost savings. The company has reorganized its supply chain and found ways to cut steel costs that, along with rising sales, drove gross profit margins to 38.2% in the most recent quarter from 34.8%. Those cost-cutting measures still have a way to run and should add another 1 percentage point to the company’s gross profit margin this year.

Although Middleby’s balance sheet doesn’t offer the debt-free beauty of that at Rogers, the company has made substantial improvements in the last year. In the most recent quarter, Middleby used cash flow to reduce debt by another $3 million to $54 million. That brought the debt-to-capital ratio down to 44% at the end of the quarter versus 64% at the end of the same quarter in 2003.

Paccar keeps rolling along
Paccar, which holds a 23% share of the U.S. market for heavy-duty trucks and makes trucks sold under the venerable Kenworth and Peterbilt brands, just keeps rolling along. Over the last 10 years, through great and lousy markets, Paccar shares have returned an annual average of 18.5%. So far this year, the stock’s been flat.

Earnings per share, which have grown at an annual average of just 4.2% for the last five years, are projected to explode by 44% this year and 20% in 2005 as a growing economy demands more trucks to ship goods.



Trucking volumes continued to accelerate in April from the already high growth rates in the first quarter. Trucking companies in both the less-than-truckload and truckload segments are increasing their capital budgets to buy more trucks in the face of tight capacity.

Truck sales volumes, which ran at near historic levels in April, should show a seasonal downtick into the fall. Then, I expect them to pick up again in October as trucking companies begin placing new orders for delivery in 2006. New Environmental Protection Agency rules on truck engine pollution should also help drive demand.

But it’s the company’s long-term approach to the short-term swings in its cyclical market that make this such a timely stock now. Paccar never overspends at the top of the cycle, and it never stints on investment at the bottom of the cycle. As a result, Paccar was able to buy European truck maker DAF in 1996 for cash and a tiny bit of debt, now repaid. The company was also able to take the risk of using Caterpillar’s new engine line, and it was willing to take a short-term hit to sales in order to keep its own technology ahead of the competition.

That kind of long-term approach has helped the company drive Selling, General & Administrative expenses down to 5% of revenue in the current year from 10% a decade ago. That’s a cost-cutting tradition that I don’t think this company is about to suddenly abandon.

Of course, the $1.4 billion in cash and short-term investments that Paccar showed at the end of the first quarter helps the company think long term. (Long-term debt stood at $1.7 billion and the debt-to-equity ratio was 0.49.)

I’m going to add one of these manufacturing companies, Rogers, to Jubak’s Picks with this column. I’d like to see how the market reacts to the June 4 payrolls and unemployment claims numbers before I decide how much to commit to this sector now.

Changes to Jubak’s Picks

Buy Rogers
Rogers (ROG, news, msgs) specializes in making the polymers and foams that form the backbone of printed circuit boards, chip packages and keyboards. It sells these products to just about all the biggest names (and some not so big) in consumer electronics. Among its customers are Nokia (NOK, news, msgs), Motorola (MOT, news, msgs), Ericsson (ERICY, news, msgs) and Siemens (SI, news, msgs). Net sales climbed by 14% in the first quarter of 2004 from the fourth quarter of 2003, paced by 18% growth in the printed circuit materials business that accounts for 46% of company revenue.

Analysts see earnings per share growing by 82% in 2004, and the stock trades at a price-to-earnings ratio of just 21.3 on those projected earnings. On the balance sheet, Rogers shows $34.5 million in cash and short-term investments and no debt. Good position for a company to be in if interest rates are headed up. I’m adding the stock to Jubak’s Picks with a December target price of $73 a share.

(Full disclosure: I will buy shares of Rogers for my personal account three days after this column is posted.)

New developments on past columns

It’s time to buy oil stocks, not sell them
The controversy over how much oil an oil company should book when it lists reserves in its financial statements just won’t die.

The newest wrinkle is an announcement from Norsk Hydro (NHY, news, msgs) that it would stand by its estimates of reserves in the Ormen Lange oil field off Norway when it filed its form 20F with the U.S. Securities & Exchange Commission. That wouldn’t be an issue except for this: Norsk Hydro’s estimate shows a 70% recovery rate from the field, or reserves of 336 million barrels of oil equivalent.

That’s far higher than the recoverable reserves booked from the same field by Royal/Dutch Shell, which is a partner in the field and which has slashed its estimates for its own reserves, including those in the Ormen field. According to current figures, the difference between the most optimistic reserve calculations and the least among the Ormen partners, which include Norway’s state oil company Petoro, Sweden’s Statoil (STO, news, msgs), BP (BP, news, msgs) and Exxon Mobil (XOM, news, msgs), amounts to a factor of four. But, hey what’s a little accounting difference of opinion among partners?

Editor's Note: A new Jubak’s Journal is posted every Tuesday and Friday.

E-mail Jim Jubak at jjmail@microsoft.com.