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1 Investment Banker Offers Up 3 Industrials Stocks to Buy

Worker in hard hat and safety vest standing next to big yellow excavating machine

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking three high-profile Wall Street picks and putting them under the microscope...

Industrial stocks have been a casualty of Donald Trump's trade war , writes Barron's . In a recent column, the business journal noted that the Industrial Select Sector SPDR ETF , a proxy for industrial stocks as a whole, has lagged the performance of the broader S&P 500 in 2018. And yet, over the past month, both the S&P 500 and the Industrial SPDR have been trending upwards. One analyst thinks the time has come for three industrial stocks in particular -- Caterpillar (NYSE: CAT) , Manitowoc (NYSE: MTW) , and Helios Technologies (NASDAQ: SNHY) -- to rake in some gains.

Here's what you need to know.

Worker in hard hat and safety vest standing next to big yellow excavating machine

Baird just upgraded three big industrial stocks. Let's dig into the logic. Image source: Getty Images.

Upgrading Caterpillar

Let's start off today's column with the highest-profile pick.

This morning, analysts at investment banker R.W. Baird announced they're upgrading shares of mining, construction, and power equipment maker Caterpillar to outperform with a $191 price target.

Last week, Caterpillar advised that its machinery sales over the past three months were up 23% year over year, leading Bloomberg to observe that Caterpillar does not appear to be suffering (yet) from the burgeoning trade war between the U.S. and China. In today's note, covered by , Baird muses that while sales to China may be peaking, Caterpillar is still enjoying growing demand in other markets, and global demand growth for Caterpillar products "should continue into 2019."

Longer-term, analysts surveyed by S&P Global Market Intelligence estimate that Caterpillar should be able to grow its profits at about 17% annually over the next five years, a fact that lends support to Baird's buy thesis.

Upgrading Manitowoc, too

In contrast to Caterpillar, which derives roughly equal amounts of revenue from the sale of construction equipment and the sale of equipment for the power generation industry (and significant revenue from mining equipment sales besides), Manitowoc's business is almost exclusively focused on selling construction equipment today.

That being said, the company does have significant geographical diversification that could insulate it from the effects of a trade war between the U.S. and China, inasmuch as the entire Middle East and Asia Pacific region combined accounts for only 16% of Manitowoc's annual sales. (The American, European, and African markets are much more important to Manitowoc.)

Baird likes Manitowoc stock as well as Caterpillar, arguing that the company has been improving both its sales (up 9% over the past 12 months in comparison to 2016 figures) and profit margins on those sales (operating profit margins, which were negative as recently as 2016, are now at 3.2%).

Like Caterpillar, Baird rates Manitowoc stock outperform, and has assigned a $32 price target.

And don't forget Helios Technologies

Last but not least, Baird assigned an outperform rating to Helios Technologies today -- and that's a name you may not be familiar with.

The Sarasota, Florida-based manufacturer of screw-in hydraulic cartridge valves, manifolds, and integrated fluid power packages and subsystems was known as " Sun Hydraulics " up until last month. The company officially changed its name in August, it says, to better reflect "its Vision 2025 strategy, which is to achieve global technology leadership in the industrial goods sector by 2025 with critical mass exceeding $1 billion in sales while maintaining superior profitability and financial strength."

Whatever name it chooses to go by, though, Baird is a fan of Helios' performance, noting that sales are growing and predicting that the company's profit margins will improve through the end of this year and into the next. Thanks in part to its recent acquisition of Custom Fluidpower, Helios' trailing-12-month sales of $406 million are more than twice what it recorded in fiscal 2016, a fact that no doubt contributed to Baird's decision to upgrade Helios stock to outperform with a $65 price target.

So how should investors react to these new ratings?

That being the case, I have to say that of the three stocks Baird is offering up as buy candidates today, Helios Technologies is my least favorite. Sales may have exploded over the past year, but Helios' operating profit margin continues to contract, down more than 10 full percentage points over the past five years.

Although Baird seems pretty optimistic about this one, when I look at Helios today, I see most analysts positing a 15% earnings growth rate, but the stock trading for well north of 50 times earnings, and generating less free cash flow than it reports as net earnings to boot. None of that adds up to a buy thesis, in my opinion.

Manitowoc is a similar story. Again, it's got a respectable growth rate -- 15%. On the surface, Manitowoc's valuation also looks a little better than Helios' at a P/E ratio of less than 20 -- but that's still no bargain on a 15% growth rate. To top it all off, after briefly turning positive in 2017, Manitowoc's free cash flow number is once again in the red for the past 12 months (negative free cash flow of $44.4 million).

And to be honest with you, I'm not even all that thrilled with Baird's suggestion to buy Caterpillar. At nearly $91 billion in market capitalization (and this is not even counting Caterpillar's near-$30 billion net debt), Caterpillar stock sells for a P/E of more than 29. So while on the one hand, the company's 17% projected earnings growth makes it arguably the best earnings growth story of the three, on the other hand, 17% growth still doesn't seem like like enough to justify a P/E of 29.

Also, the stock's free cash flow number is only $2.1 billion, which is significantly less than its reported earnings of $3.1 billion. This basically means that for every $1 in profit that Caterpillar claims to be earning, it's actually collecting only about $0.68 in actual cash profit -- which is not a great number.

Long story short, Baird doesn't seem to think the risk of a trade war should scare investors away from these stocks. As for me, though, I don't think you need a trade war to find a reason to avoid them. These stocks are already too expensive without it.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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