For the second time in twenty years, machinery stocks trade at a premium to multi-industry. That’s what should happen at a trough. In the deep trough of 2009, machinery revenues had fallen 60-70% in trucks and construction, far steeper than the more diversified multi industry group would ever see.  As equipment inevitably ages out, those revenues were too low, and so stocks properly discounted a steeper upward rebound.  Today the justification is less clear.

Are we at trough now? CAT is, the rest of Machinery is not.   Sum up group revenues, and compare versus the 2012 revenue peak.  CAT is ~65% of the revenue shortfall in all of machinery, versus 25% of revenues.  Put CAT revenues back to peak, as has happened by now in every prior downturn, and the group would be within 5% of peak revenues. Versus the 2014 revenue peak, CAT is 35% of the shortfall.

The actual gap is larger than that however.  Many of CAT’s end markets simply haven’t yet seen a recovery, and so the cumulative shortfall of machines not built is large.  Other verticals are seeing shallow bottoms after record strength…long haul trucks had five consecutive high years followed by two normal ones, ag tractors had eight consecutive record years, followed by two normal ones.  CAT in contrast has seen no real recovery since 2008 in heavy construction, a mining collapse since 2013, powergen weakness since 2011, locomotives near zero in NA, and other end markets weak as well. We increasingly think fleets are what drive unexpected volatility in machinery, and are what is under analyzed.  Fleets at CAT are old, fleets in much of the rest of machinery are new.

Why not a negative group rating and more underweight sell ratings? Right now valuation is the only issue, and investors often get machinery valuations backwards.  Underlying demand is strong.  North American construction is touching prior highs, and high frequency indicator Komtrax shows dirt being moved growing single digits after a long weak stretch.  Trucking rates and utilization are picking up; the indicators are volatile and low quality, but all pointing positive.  Blow up risks are low…there’s no housing crisis that lurked beneath strong machinery results in 2007-8.  Machinery multiples should have already contracted, but too often shares trade at high multiples on high earnings for too long.

We have our highest Buy-Accumulate ratings on two stocks, CAT and URI. Overweight rated stocks have less upside, but will drift up in a recovery: Cummins, with EM exposure at deep troughs. Volvo, proving out high margins at middling volumes. Stanley Black and Decker, on excellent execution and growth. Wabco with structural growth, Ashtead/Sunbelt on construction in the US, and Lincoln Electric are our other Overweights.

We are Underweight five stocks where upside surprise is less likely than the multiples imply: PCAR and NAV shares in trucks, HRI shares in rental, with a tough 2H to make numbers, and TEX and MTW in lifting.