Industrial Sector Ideas

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Donaldson -- >>> Are Purification Stocks Worth Investing In?



By Zain Abbas

April 3, 2013



http://beta.fool.com/superbanalyst/2013/04/03/are-purification-stocks-worth-investing/28617/?source=eogyholnk0000001



After reaching their 52 weeks high, the suppliers of filtration and purification technologies are not currently being recommended by the Street as well as investors. I have picked out two stocks and tried to analyze whether they still have some spice to go up or not.

Donaldson Company (NYSE: DCI)

Investment Thesis: Higher aftermarket penetration rates are likely to materialize as new technology becomes a bigger part of the installed base. Expectations have now also been reset for a slower ramp in engine OEM production.

Contrarian Idea: It is suspected that it will likely take until second half of the calendar year 2013 to see some modest improvement in OEM engine production. On the engine side, revenue declines of ~0.8% and operating margins in the ~13.8% range are expected for FY2013. However, on the positive side, the negative mix impact with higher gas turbine sales are expected to continue for the balance of the year although they should moderate slightly as incremental cost reduction actions take hold. Overall, industrial revenue is expected to be up by ~5.4% and margins are expected in the ~15.5% range in FY 2013.

Key Catalysts: A faster ramp on the engine side with better truck builds, higher aftermarket penetration and Asia improving could be a positive catalyst when the company reports earnings. Other macro data points on equipment utilization and global industrial production are also expected to produce a noticeable movement in the stock price.

Valuation: The shares of the company are currently trading at a forward multiple of 18.5 times, down from the historical average of 20x.

Pall Corporation (NYSE: PLL)

Investment Thesis: Pall’s cost restructuring is in its early innings and should help margins. Longer-term, the management will be more aggressive in using the under-levered balance sheet to drive shareowner value. Not only this, the company is coming up with newer products to keep a competitive edge. A good example can be found in the form of Gaskleen, a new purifier used for cost control and deriving benefits from economies of large scale of production of light emitting diodes. Gaskleen is expected to deliver pure ammonia which will improve the luminosity of LEDs and hence help to increase the life of purifiers. This invention was welcomed by Royal Phillips Electronics (NYSE: PHG), one of the leading manufacturers of LED based lighting and automotive lamps.

Contrarian Idea: Overall, the industrial revenue growth is expected to be down in mid-single digits in FY2013. The current destocking relates to ~1/3 of slower demand in industrial end markets. It is suspected that this process will take at least another quarter or two before production levels ramp up. 2/3's of total China sales are Industrial with the remainder Life Sciences. Food and Beverage end markets are expected to see little growth due to continued weakness in Europe.

Key Catalysts: The use of an extremely under-levered balance sheet to do accretive deals is a key catalyst for the stock. In addition, cost restructuring running ahead of plan combined with PLL’s industrial business recovering (microelectronics, process technologies) should help longer term margins.

Valuation: Pall is trading at 18.8 times FY2014 EPS, which is conservative and does not include any acquisitions. Why I say that the stock is currently cheap is because Pall historically trades closer to 21 times forward earnings.

Foolish bottom line

These filtration stocks are definitely set for some more capital appreciation given their momentum to achieve both top and bottom-line growth.

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