Developing A Valuation Model and Using The Knowledge … · 2018-04-03 · Developing A Valuation Model and Using The Knowledge MORGAN STANLEY RESEARCH North America Electrical Equipment

Developing A Valuation Model and Using The Knowledge MORGAN STANLEY RESEARCH North America

Electrical Equipment & Multi Industry

Nigel Coe, CFA

[email protected]

212 761 5574

Source: Shutterstock

September 2017

A Stock Analyst’s Perspective

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have

a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in

making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

mailto:[email protected]

M O R G A N S T A N L E Y R E S E A R C H

2

Biography

• Nigel is a Managing Director at Morgan Stanley and

has led the US Cap Goods equity research team at

Morgan Stanley since September 2011.

• Nigel has covered the US Multi-Industry sector for

more than 12 years (MS, DB) and has been an equity

research analyst for 18 years, based in US, Europe

and Asia (DB, DLJ).

• Consistently ranked as a top-3 sell-side analyst in the

Institutional Investors All American Research (II) poll.

• BS in Mathematics from the University of

Southampton, Chartered Financial Analyst (CFA) and

a Fellow of the Institute of Chartered Accountants in

England & Wales.

Nigel Coe

US Electrical Equipment and Multi-Industry


3

What Is the Multi-Industry Group?


4

Multi-Industry Stocks Are Among the Largest US Industrials

0 20,000 40,000 60,000 80,000 100,000 120,000 140,000

Ryder System Inc

Quanta Services Inc

Robert Half Intl Inc

Flowserve Corp

Jacobs Engineering Group…

Stericycle Inc

Fluor Corp

Allegion plc

Acuity Brands Inc

Xylem Inc

Snap On Inc

Fortune Brands Home &…

Kansas City Southern Inc

Hunt J.B. Transport Services

Expeditors Intl of WA Inc

United Rentals Inc

Masco Corp

CH Robinson Worldwide Inc

Alaska Air Group Inc

Pentair PLC

Arconic Inc

AMETEK Inc

Dover Corp

TransDigm Group

Textron Inc

Rockwell Collins

Cintas Corp

L3 Technologies, Inc

Grainger W.W. Inc

Fastenal Co

Verisk Analytics Inc

Nielsen Holdings plc

Equifax Inc

Rockwell Automation Inc

Stanley Black & Decker

Parker-Hannifin Corp

Fortive Corp

Roper Technologies, Inc

Republic Services Inc

Ingersoll-Rand Plc

United Continental Holding…

American Airlines Group Inc.

PACCAR Inc

Cummins Inc

Waste Management Inc

Delta Air Lines

Southwest Airlines Co

Eaton Corp plc

Deere & Co

Norfolk Southern Corp

Emerson Electric Co

Johnson Controls…

Northrop Grumman Corp

CSX Corporation

Raytheon Co

Illinois Tool Works Inc

FedEx Corp

Caterpillar Inc

General Dynamics

United Parcel Service Inc B

Lockheed Martin

Union Pacific Corp

United Technologies Corp

Honeywell Intl Inc

Boeing Co

3M Co

General Electric Co

Industrial Select Sector (XLI) - Individual Holdings Ranked by Market Capital*

Source: Standard & Poor's Financial Services LLC, Morgan Stanley Research. Data as of 04/24/2016. Yellow denotes MS EE/MI coverage.

*GE Market Capital is ~$258bn.

Aerospace & Defense, 22.66%

Industrial Conglomerates,

20.22%

Machinery12.81%

Road & Rail8.30%

Air Freight & Logistics, 6.93% Airlines

6.43%

Airlines, 5.76%

Commercial Services & Supplies,

4.23%Commercial Services &

Supplies, 3.14%

Professional Services, 2.90%

Trading Companies & Distributors, 1.97%

Construction & Engineering, 1.08%


5

Industrial and Manufacturing

15%

Residential / Home & Consumer

13%

Commercial & Institutional

Construction/Renovation

20%

Aerospace & Defense15%

Auto & Truck9%

Technology/Telecom

5%

Healthcare7%

Oil & Gas / Other Process

9%

Power Gen/Utility11%

Multi-Industry End Market and Cycle Exposures

Source: Company Data, Morgan Stanley Research. *GE Excludes GE Capital.

Consolidated End Market Exposure


6



General Industrial12%

Commercial Aerospace11%

Power Generation9%

Building equipment (Non-Resi)8%

Healthcare7%

Oil & Gas7%

Fire & Security (Non-Resi)7%

HVAC/R (Non-Residential)5%

Auto OEM5%

Defense4%

HVAC/R (Residential)4%

Building Equipment (Residential)

3%

Transmission & Distribution2%

IT/Electronics2%

Tools (Commercial)2% Heavy Truck/Trailer

2%

Other2%

Consumer and Retail2%

Retail Refrigeration & Food Prep1%

FMCG1%Chemicals

1%

Water & Wastewater1%

Tools (Residential)1%

Other Process1%

Fire & Security (Residential/Retail)

1%

Telecom1%

Metals & Mining 0%

Detailed End Market Exposure


7

Early22%

Mid29%

Late31%

No Cycle14%

Defense4%



Cycle Exposure


8

Multi-Industry Geographic Exposures

Source: Company Data, Morgan Stanley Research.

Geographic Revenue Exposure - EMEA

Geographic Revenue Exposure - ROW Geographic Revenue Exposure - APAC

Geographic Revenue Exposure - US

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9

What Drives Multi-Industry Revenue?


10

Multi-Industry Sales Are Driven by Global GDP

Source: Morgan Stanley Research and forecasts as of 4/24/2017; IMF

Global Growth Outlook

The global economy entered 2017 on a firm footing, with upside surprises in economic data at their highest since 2010 in March. Our economists’ base case is for a synchronous recovery in both DM and EM as DMs have exited deleveraging and EMs have exited the adjustment phase.

A positive feedback loop of improvement in DM domestic demand supporting EM exports and reduced disinflationary pressures from EM supporting DM reflation should sustain the recovery. As a result, our economics teams expect global growth will likely come in at or slightly above its long-term average over the coming quarters.

The MS Global Economics Team forecasts 3.6% global GDP growth in 2017, with accelerating growth trends as the year plays out. The acceleration by relatively strong DM and EM

contribution.

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e

Real Global GDP Growth EE/MI Organic Growth

Correlation: 0.92

Since 2000, the Multis group has shown a 0.92 correlation to Global GDP growth, with a higher level of cyclicality (1.3x

average multiplier).

Global* 3.4% 3.4% 3.1% 3.6% 3.7%

G10 1.7% 2.0% 1.6% 2.0% 1.8%

US 2.4% 2.5% 1.6% 2.2% 2.2%

Euro Area 0.9% 1.4% 1.7% 1.9% 1.6%

Japan 0.0% 1.0% 1.0% 1.6% 1.1%

UK 2.8% 2.7% 1.8% 1.7% 1.1%

EM 4.8% 4.4% 4.2% 4.7% 5.0%

China 7.4% 7.0% 6.7% 6.6% 6.4%

India 7.2% 7.7% 7.9% 7.6% 8.0%

Brazil 0.1% -1.5% -3.6% 0.5% 2.5%

Russia 0.6% -5.0% -0.2% 1.5% 1.8%

2018eReal GDP (%Q, SAAR) 2014 2015e 2016e 2017e


11

US Industrial Production Is Another Important Proxy

Source: Morgan Stanley Research, Federal Reserve, Thomson Reuters.

Industrial production: a measure of output in the industrial sector of the economy, which includes manufacturing, mining, electric and gas industries. The industrial sector, together with construction, accounts for the bulk of the variation in national output over the course of the business cycle. The US IP index measures real output of the industrial economy and is expressed as a percentage of real output in a base year, currently 2007.

Growth in US Industrial Production has recovered from a modest recession in 2016 – inflecting to slightly

positive through 2Q17.

Broadly, the group shows a high degree of correlation to US Industrial Production (0.72, last 10 Years), with greatest

correlation at FTV, ITW, IR, HON, ROK, and ETN.

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Correlation: Organic Growth vs. US IP

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Industrial Production Manufacturing

Electrical Power Generation Mining/Oil Field Machinery


12

The Importance of End Market Exposure


The rationale for the diversified business structure is to provide stable growth across the cycle by maximizing growth and minimizing volatility. Ways to do this include diversified end market exposures as well as greater mix of MRO and service revenue stream

Multis organic growth had been modestly negative through 2016. However, we have seen an inflection into 2017, with organic growth up 2.8% and 3.4% in 1Q and 2Q, respectively.


13

The Importance of End Market Exposure


The rationale for the diversified business structure is to provide stable growth across the cycle by maximizing growth and minimizing volatility. Ways to do this include diversified end market exposures as well as greater mix of MRO and service revenue stream

DOV, FAST, and LII led growth in 2Q while large-project exposed names (FLOW, PNR, and WCC) continued to lag the group.

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2QCY17 Organic Growth


14

End Market Demand Levels vs. Prior Peak Levels


End market balance is critical to delivering revenue stability as can be seen here: Consumer exposures are generally well ahead of prior cycle peaks, while Heavy Industries are approaching trough.

Looking across EE/MI end markets, we see Auto, Healthcare, E&E, and Distributors well ahead prior peak levels, while Mining Equipment, Construction Equipment, and Ag Equipment remain well below prior peaks.

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12%

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2017e Revenue vs. Prior Peak


15

How Well Diversified is your Industrial?


Generally larger industrials show lower volatility of revenue growth. Companies like UTX, GE and HON have large exposure to stable service streams, while 3M and ITW are more consumables driven..

Cross-Cycle (L7Y) Organic Growth CAGR sits at +0.7% for the group, with best growth at ROK, MMM, and JCI.

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Organic Growth CAGR - Last 7 Years


16

How Well Diversified is your Industrial?


Generally larger industrials show lower volatility of revenue growth. Companies like UTX, GE and HON have large exposure to stable service streams, while 3M and ITW are more consumables driven..

Volatility in organic sales cross-cycle highlights well diversified portfolios at UTX, GE, MM and HON. Broadly, DOV, ROK, and ETN have more cyclical exposures.

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Organic Sales Volatility - Last 7 Years


17

What is the Outlook for Cap Goods Revenues?


18

PMIs Are Closely Tracked as a Barometer of Future Sales

Source: Morgan Stanley Research, ISM, Thomson Reuters.

ISM / Purchasing Managers Index (PMI): Data for the US ISM are collected from more than 300 purchasing and supply executives from across the country, who respond to a monthly questionnaire designed to elicit fact, not opinion, about changes in production, new orders, new export orders, imports, employment, inventories, prices, lead-times, and the timeliness of supplier deliveries, comparing the current month to the previous month.

The PMI is constructed as a diffusion index, which has the properties of a leading indicator and shows the prevailing direction of an indicator change and the scale of that change. A PMI reading >50% indicates that the manufacturing economy is generally expanding; <50%, it is generally declining.

US PMI: Near Cycle Highs, Now At 58.8 China PMI: Recovering From Stagnation, Now At 52.4

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China PMI


19

PMIs Are Closely Tracked as a Barometer of Future Sales (Continued)

Source: Morgan Stanley Research, ISM, Thomson Reuters.

ISM / Purchasing Managers Index (PMI): Data for the US ISM are collected from more than 300 purchasing and supply executives from across the country, who respond to a monthly questionnaire designed to elicit fact, not opinion, about changes in production, new orders, new export orders, imports, employment, inventories, prices, lead-times, and the timeliness of supplier deliveries, comparing the current month to the previous month.

The PMI is constructed as a diffusion index, which has the properties of a leading indicator and shows the prevailing direction of an indicator change and the scale of that change. A PMI reading >50% indicates that the manufacturing economy is generally expanding; <50%, it is generally declining.

Eurozone PMI: Accelerating Past Post Recession Highs Global PMI: Showing Strong Acceleration to 53.1

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20

But We Prefer Our Proprietary CAPMI as a Lead Indicator

Source: Morgan Stanley Research

CAPMI was flat M/M at 54 in August, as industrial momentum

remained stable and consistent with the theme of steady

expansion.

CAPMI turned positive (>50) in May 2016, which corresponds

to the bottom in the industrial cycle. Since then, we saw

acceleration and more recently stabilization at highs

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MS CAPMI

The Morgan Stanley Capital Goods Momentum Index (CAPMI) is a diffusion index that measures the month-over-month momentum of 48 key global macro and industry indicators. Overall, the index composition is largely consistent with our companies’ geographic exposure, with 42% from North America, 19% Europe, 19% APAC and 21% Global. It also includes KPI's for the major end markets to which our companies are exposed, including Aerospace, Automotive, Construction, Oil & Gas, HVAC, Power and Technology.

The index has a central value of 50; a reading of 50 indicates that the overall trend is stable on a monthly sequential basis. A reading over 50 indicates accelerating growth, while a reading below 50 indicates decelerating growth. However, we prefer to look at the second derivative of the index: i.e. a clear upward trend in the diffusion index below 50 is often a more powerful indicator than a downward trend below 50 – it’s really all about acceleration and deceleration of the index.


21

But We Prefer Our Proprietary CAPMI as a Lead Indicator (Continued)


We are seeing broad strength in Global indicators, with

Europe leading the way, US remaining stable, and APAC

decelerating

CAPMI tends to lead EE/MI organic growth by 6/9 months.

Recent strength suggests an acceleration in organic growth

into 2018.

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US3M Rolling

Europe3M Rolling

APAC3M Rolling

Global3M Rolling

CAPMI Readings by Region

Jun-17 Jul-17 Aug-17

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MS CAPMI

EE/MI Quarterly Organic Growth

The Morgan Stanley Capital Goods Momentum Index (CAPMI) is a diffusion index that measures the month-over-month momentum of 48 key global macro and industry indicators. Overall, the index composition is largely consistent with our companies’ geographic exposure, with 42% from North America, 19% Europe, 19% APAC and 21% Global. It also includes KPI's for the major end markets to which our companies are exposed, including Aerospace, Automotive, Construction, Oil & Gas, HVAC, Power and Technology.

The index has a central value of 50; a reading of 50 indicates that the overall trend is stable on a monthly sequential basis. A reading over 50 indicates accelerating growth, while a reading below 50 indicates decelerating growth. However, we prefer to look at the second derivative of the index: i.e. a clear upward trend in the diffusion index below 50 is often a more powerful indicator than a downward trend below 50 – it’s really all about acceleration and deceleration of the index.


22

2017 Appears to Be a Year of Inflection, with Capex Expected to Grow ~4%

Source: Morgan Stanley Research, Thomson Reuters, Company Data.

Bottom Up Capex Tracker. We track guidance from ~200 companies across the Cap Goods sector to determine the outlook for capital expenditures over the next 12 months. Our tracker forecast double digit declines in capex in 2015/16; however 2017 is expected to be an inflection year driven by increased O&G spending.

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Rail

Diversified Industrial

Electric Utilities

Food & Staples Retailing

Chemicals

Automotive

Ex-O&G, Mining, Utilities

Airlines

US Healthcare Facilities

Equal-Weighted Average

Median

Total Sum-Weighted

Machinery

Metals & Mining

O&G - Midstream Energy

Food & Beverage

O&G - Refining & Marketing

O&G - Integrated

Total Oil & Gas / Energy

Semiconductors

O&G - Exploration & Production


23

Water, O&G, and Food & Staples Retailing Have the Most Upside to Mid-Cycle

Source: Morgan Stanley Research, Thomson Reuters, Company Data.

Mid-Cycle Capex Outlook. We now see above mid-cycle capex levels (by 2018) in Airlines, Semiconductors, Chemicals, and Electric Utilities. On the other hand, Public Water, Oil & Gas, Food & Staples Retailing, and US Resi Construction have the most upside to mid-cycle levels.

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spit

als

Tru

ck

Au

tom

oti

ve

US

Res

i Co

nst

ruct

ion

No

n-F

oo

d R

eta

il

Rai

l

Foo

d &

Bev

erag

e

Ind

epen

den

t P

ow

er…

Me

tals

& M

inin

g

US

No

n-R

esi C

on

stru

ctio

n

Foo

d &

Sta

ple

s R

etai

ling

Oil

& G

as

Pu

blic

& P

riva

te W

ater

…


24

Where Are We in the Inventory Cycle?


25

Global Inventory Levels Back In Balance – Destocking Headwinds Gone

Source: Morgan Stanley Research, Thomson Reuters.

The Global Inventory Cycle: Inventory levels are an important leading indicator, as major shifts tend to amplify overall end user demand, resulting in larger swings in sector organic growth vs. overall global IP. This is especially true during a downturn – as growth slows, OEMs and distributors rapidly cut inventory levels in order to realign stock with lower levels of end user demand. We analyze inventory data stretching back to 1998 for ~300 companies across 11 key Cap Goods customer verticals. Aggregating global inventory/sales ratios helps to contextualize current inventory levels vs. historical norms, which in turn helps to pinpoint which verticals have most scope for restocking/destocking.

Inventories ticked up sequentially to 16.2% of sales compared to 15.8% in 1Q17, slightly above the 5Y average +20bps sequential step up in 2Q.

13%

14%

15%

16%

17%

2Q

08

4Q

08

2Q

09

4Q

09

2Q

10

4Q

10

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

4Q

15

2Q

16

4Q

16

2Q

17

Average Ex-US Home Centers 3YAverage

7YAverage


26



All subsectors saw Q/Q inventory build with the only exception of Home Centers (-130bps), and the majority of industries are now above or in line with long-term average inventory trends (+80bps above 7Y Inventory/Sales

ratio).

Airlines 2.1% 2.1% 0.0% 2.1% 0.1% 2.0% 0.1% 2.2% -0.1%

Automotive 11.8% 11.4% 0.4% 11.5% 0.2% 11.1% 0.7% 11.0% 0.8%

Chemicals 16.2% 15.9% 0.3% 16.3% -0.1% 15.6% 0.7% 15.1% 1.1%

Home Centers (US Only) 15.0% 16.3% -1.3% 15.4% -0.4% 15.6% -0.6% 16.2% -1.2%

Industrial Distributors 16.2% 16.1% 0.1% 16.0% 0.2% 15.8% 0.4% 15.6% 0.6%

EE/MI / Industrials 17.9% 17.2% 0.7% 17.4% 0.5% 17.0% 0.9% 17.5% 0.4%

Machinery 25.7% 24.4% 1.3% 26.1% -0.4% 24.0% 1.7% 22.7% 3.0%

Metals 22.0% 21.6% 0.5% 20.6% 1.4% 20.4% 1.6% 20.9% 1.1%

Mining 20.3% 19.8% 0.4% 20.8% -0.5% 22.0% -1.7% 20.1% 0.2%

Paper & Packaging 14.3% 13.9% 0.4% 14.7% -0.4% 13.8% 0.5% 13.7% 0.6%

Semiconductors 15.2% 15.1% 0.1% 15.2% 0.1% 14.4% 0.8% 14.2% 1.1%

Total Average 16.1% 15.8% 0.3% 16.0% 0.1% 15.6% 0.5% 15.4% 0.7%

Total Average (ex-US Home Centers) 16.2% 15.8% 0.4% 16.1% 0.1% 15.6% 0.6% 15.3% 0.9%

Industry

Inventory/Sales

2Q17 1Q17 Q/Q 2Q16 Y/Y2Q17 vs.

7Y Average

2Q17 vs.

3Y Average

3Y

Average

7Y

Average


27



1.60x

1.62x

1.64x

1.66x

1.68x

1.70x

1.72x

1.74x

1.76x

1.78x

1.80x

200,000

210,000

220,000

230,000

240,000

250,000

260,000

270,000

280,000

Jul-1

0

No

v-1

0

Ma

r-1

1

Ju

l-1

1

No

v-1

1

Ma

r-1

2

Ju

l-1

2

No

v-1

2

Ma

r-1

3

Jul-1

3

No

v-1

3

Ma

r-1

4

Ju

l-1

4

No

v-1

4

Ma

r-1

5

Ju

l-1

5

No

v-1

5

Ma

r-1

6

Jul-1

6

No

v-1

6

Ma

r-1

7

Ju

l-1

7

Durables ex-Transport Inventory/Shipments

On an absolute basis, US Durable Goods inventories have continued step up and are now 0.4% higher than January 2015's peak of ~$268bn. On an inventory/sales basis, days on hand remained in a tight range, with 2Q17 days on hand of ~1.70x vs. ~1.69x in 1Q - above cross-cycle averages (10Y

average of 1.63x), albeit still below its 2015 highs of 1.75x.


28



Compared to L1Y average, elevated days on hand have been driven by Automobiles, Household Appliances, and HVAC & Refrigeration Equipment. Conversely, inventories/shipments look light within Construction

Machinery, Commercial Aircraft Engine & Parts and Mining and O&G field Machinery .

-15% -10% -5% 0% 5% 10% 15%

Mining, Oil & Gas Field Machinery

Commercial Aircraft Engine & Parts

Construction Machinery

Heavy Duty Truck

Non-Defense Capital Goods Ex-Aircraft

Durables Ex-Transport

Farm Machinery

Defense Aircraft Engine & Parts

Turbines & Turbine Generator Set Units

Industrial Machinery

Electric Lighting Equipment

Electrical Equipment

HVAC & Refrigeration Equipment

Household Appliances

Automobiles

Inventory/Shipments vs. L1Yr Average


29

What Is the Outlook for Margins?


30

Multi-Industry Margins Continue to Reach New Peaks

Source: BLS, Company Data, Morgan Stanley Research.

10%

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

Core EBITDA Margins 10Y Median

EE/MI Core EBITDA Margins have hit record levels this cycle – 3ppts above prior cycle peak –

we see further expansion in 2017e


31

Multi-Industry Margins Continue to Reach New Peaks


Core OM by Company (2016)

0%

5%

10%

15%

20%

25%

MM

M

ITW

AM

E

FT

V

RO

K

HO

N

EM

R

PN

R

UT

X

Me

dia

n

HU

BB

SW

K

DO

V LII IR

ET

N

JC

I

RB

C

FL

OW

GE


32

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

EE/MI Average Restructuring as a % of Sales 10Yr Median

What Has Changed to Support Higher Margin Levels?


Restructuring has been elevated and reached its highest level during

the downturn in 2015


33

What Has Changed to Support Higher Margin Levels?


R&D intensity has picked up relative to the previous cycle and is

expected to remain elevated as companies invest for further growth

2.5%

2.6%

2.7%

2.8%

2.9%

3.0%

3.1%

3.2%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16


34

Pricing Power Remains Robust, Despite Recent Deflation


Capital Equipment pricing in the US accelerated ~10bps M/M to +0.9% Y/Y in July, which compares to +0.8%

average inflation in 2Q17. European pricing also moved sequentially higher, up 0.1% M/M to 1.0% in June vs. a

2Q17 average of +0.9% and 1Q17 average of +0.8%.

-2%

-1%

0%

1%

2%

3%

4%

5%

Jul-9

6

Ju

l-9

7

Ju

l-9

8

Ju

l-9

9

Ju

l-0

0

Ju

l-0

1

Ju

l-0

2

Jul-0

3

Ju

l-0

4

Ju

l-0

5

Ju

l-0

6

Ju

l-0

7

Ju

l-0

8

Ju

l-0

9

Jul-1

0

Ju

l-1

1

Ju

l-1

2

Ju

l-1

3

Ju

l-1

4

Ju

l-1

5

Ju

l-1

6

Jul-1

7

US

Europe


35

Pricing Power Remains Robust, Despite Recent Deflation


When we refine our view by looking at average US pricing for key EE/MI end markets*, pricing has

continued to accelerate on a sequential basis. Pricing improved 1.2% Y/Y in July, vs. the 2Q17 average

of +0.8%.

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

Jul-1

6

Au

g-1

6

Se

p-1

6

Oct-

16

Nov-1

6

Dec-1

6

Jan

-17

Fe

b-1

7

Ma

r-17

Ap

r-17

Ma

y-1

7

Jun

-17

Jul-1

7


36

Raw Material Inflation Could Be a Meaningful Headwind into 2018


US HRC steel (Mid West $/ton)


37



Copper Pricing


38



Aluminum Pricing


39



If we extrapolate the current trend, our gross margin barometer suggests that the US Cap Goods price/cost gap

will remain in negative territory through YE2017, albeit at a moderating pace, i.e. 2Q17 represented the point of

peak pressure. That said, we are not expecting any meaningful recovery of price/cost in 2H17.


40

How Does the Multi-Industry Group Trade?


41

The Group Trades at ~19.1x Consensus Estimates, a ~7% Premium to the S&P 500

The rally has been driven by impressive multiple

expansion from 14-15x at YE15 to a peak of ~20x.

Multiples are off their highs but remain elevated at

~19.1x.

Source: Priced as of April 21 2017; Morgan Stanley Research, Thomson Reuters.

9x

11x

13x

15x

17x

19x

21x

Sep

-07

Sep-0

8

Sep

-09

Sep

-10

Sep

-11

Sep

-12

Sep

-13

Sep

-14

Sep-1

5

Sep

-16

Sep

-17

EE/MI NTM P/E Current 10Y Median 1Y Median

The EE/MI relative multiple has also expanded from a

discount to a current premium of 6.8% - this is very

modestly below trend and so keeps us at an In-Line

sector view, despite elevated absolute multiples.

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Sep

-07

Ma

r-08

Sep

-08

Ma

r-09

Sep

-09

Ma

r-10

Sep

-10

Ma

r-11

Sep

-11

Ma

r-12

Sep

-12

Ma

r-13

Sep-1

3

Ma

r-14

Sep

-14

Ma

r-15

Sep

-15

Ma

r-16

Sep

-16

Ma

r-17

Sep

-17

NTM P/E vs. S&P 500 1Y Median 10Y Median


42

Sector Multiple Has Become Very Expensive on a P/E-G Basis

-5%

0%

5%

10%

15%

20%

25%

10.0x

12.0x

14.0x

16.0x

18.0x

20.0x

Sep

-07

Mar-

08

Sep

-08

Mar-

09

Sep

-09

Mar-

10

Sep

-10

Mar-

11

Sep

-11

Mar-

12

Sep

-12

Mar-

13

Sep

-13

Mar-

14

Sep

-14

Mar-

15

Sep

-15

Mar-

16

Sep

-16

Mar-

17

Sep

-17

NTM P/E (LHS) Consensus NTM EPS Growth (RHS)

Recent price performance has been driven by multiple expansion and NTM EPS revisions, with estimates up from 5% to ~10%.



43

The Group’s Premium to the S&P Generally Tracks the ISM Trend

Source: Morgan Stanley Research, Thomson Reuters, ISM

40

45

50

55

60

65

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

Aug-0

1

Aug-0

2

Aug-0

3

Aug-0

4

Aug-0

5

Aug-0

6

Aug-0

7

Aug-0

8

Aug-0

9

Aug-1

0

Aug-1

1

Aug-1

2

Aug-1

3

Aug-1

4

Aug-1

5

Aug-1

6

Aug-1

7

Relative EE/MI Multiple (Left) ISM (Right)


44

Cyclical Stocks Are Moving Closer to Parity with Defensives

Investors have moved back into cyclical names, which now trade at only a 1.0x discount


-5x

-4x

-3x

-2x

-1x

0x

1x

2x

3x

4x

5x

Sep-0

7

Ma

r-0

8

Sep-0

8

Ma

r-0

9

Sep-0

9

Ma

r-1

0

Sep-1

0

Ma

r-1

1

Sep-1

1

Ma

r-1

2

Sep-1

2

Ma

r-1

3

Sep-1

3

Ma

r-1

4

Sep-1

4

Ma

r-1

5

Sep-1

5

Ma

r-1

6

Sep-1

6

Ma

r-1

7

Sep-1

7

Multiple Gap - Defensive vs. Cyclical 10 Yr Median 1Yr Median


45

We've seen dispersion flip with rising oil prices - O&G-

exposed names now trade at a 2.7x premium to least exposed

stocks.

Conversely, the gap has expanded recently between construction and non-construction stocks, with construction

stocks trading at a 3.9x discount.


-3x

-2x

-1x

0x

1x

2x

3x

4x

5x

Sep-0

7

Ma

r-0

8

Sep-0

8

Ma

r-0

9

Sep-0

9

Ma

r-1

0

Sep-1

0

Ma

r-1

1

Sep-1

1

Ma

r-1

2

Sep-1

2

Ma

r-1

3

Sep-1

3

Ma

r-1

4

Sep-1

4

Ma

r-1

5

Sep-1

5

Ma

r-1

6

Sep-1

6

Ma

r-1

7

Sep-1

7

Multiple Gap - Oil & Gas vs. Non-Oil & Gas 10Yr Median 1Yr Median

-6x

-5x

-4x

-3x

-2x

-1x

0x

1x

2x

Sep-0

7

Ma

r-0

8

Sep-0

8

Ma

r-0

9

Sep-0

9

Ma

r-1

0

Sep-1

0

Ma

r-1

1

Sep-1

1

Ma

r-1

2

Sep-1

2

Ma

r-1

3

Sep-1

3

Ma

r-1

4

Sep-1

4

Ma

r-1

5

Sep-1

5

Ma

r-1

6

Sep-1

6

Ma

r-1

7

Sep-1

7

Multiple Gap - Construction vs. Non-Construction 10Yr Median 1Yr Median

O&G Has Moved into Favor While Construction Has Fallen Further Out


46

What Factors Drive Performance?


47

What Factors Drive Performance for the Multis?


Factor Analysis. In our factor analysis, we rank stocks into tertiles (three equal groups) for each factor (for example, US Sales Exposure), from highest to lowest. For each year over the past decade, we then calculate the spread between the average price performance for stocks in the top tertile versus the bottom tertile, or T1 (for example, stock price performance for companies with the most US Sales Exposure) minus T3 (stocks with the least US sales exposure). EPS Momentum has been the most effective performance factor over time. Conversely, we find Change in Leverage and Dividend yield are the two strongest perverse factors.


48





49


Source: Morgan Stanley Research -10% 0% 10% 20%

Change in Dividend Payout Ratio

Change in net leverage (EBITDA turns)

Change in R&D

Beginning of Year P/E vs. 5Yr Avg

Prior Year Mean Reversion

Dividend Yield (as of Jan 1)

M&A Activity

Restructuring Activity

CapEx to Sales

Increase in CapEx to Sales

Share Buybacks as % of DWAC

P/E Ratio

Net Leverage

R&D

Increase in Share Buybacks ($) Y/Y

ROIC

US Exposure

ROE

Absolute Core Margin

Invested Capital (Y/Y)

Beginning of Year P/E vs. 1Yr Avg

FCF Yield

Core Margin Expansion

Organic Growth

Incremental ROIC (Y/Y Change)

Current Year EPS Revisions

Annual Outperformance /Underperformance (L10Yrs)



50

Earnings Revisions Have Been Modestly Positive for 2017 so Far…

FY17 EPS expectations are now down ~9% from initiation. However, we have seen signs of stabilization recently.

Source: Morgan Stanley Research, Thomson Reuters. As of April 20, 2016.

-20%

-15%

-10%

-5%

0%

5%

Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17

Baseline FY2013 FY2014 FY2015 FY2016 FY2017


51

… for Bulk of Coverage

We’ve begun to see some signs of stabilization in EPS revisions, with CY2017 EPS expectations up 30bps since

Jan-1

Source: Morgan Stanley Research, Thomson Reuters. As of April 20, 2016.

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

RO

K

EMR

FAST

DO

V

PN

R

ETN

ITW

FTV

SWK

MM

M

WSO

AM

E

Me

dia

n

HU

BB

RB

C IR LII

HO

N

UTX JC

I

WC

C

GE

GW

W

FLO

W

HD

S

EPS Revisions Since Jan-1


52

Case Study - Dover


53

Case Study: Dover

YE 31 December ($m) 2013 2014 2015 2016 1Q17 2Q17 3Q17E 4Q17E 2017E 1Q18E 2Q18E 3Q18E 4Q18E 2018E 2019E 2020E 2021E

Sales 7,516 7,753 6,956 6,794 1,813 1,993 1,996 2,033 7,835 1,899 2,058 2,106 2,162 8,225 8,781 9,130 9,465 YoY total growth 8% 3% -10% -2% 12% 18% 17% 14% 15% 5% 3% 5% 6% 5% 7% 4% 4%YoY organic growth 2% 4% -10% -6% 4% 10% 7% 7% 7% 4% 2% 5% 6% 4% 7% 4% 4%

Cost of sales 4,604 4,778 4,388 4,322 1,152 1,244 1,235 1,279 4,909 1,178 1,276 1,291 1,343 5,088 5,355 5,535 5,709

Gross profit 2,911 2,974 2,568 2,471 661 749 761 754 2,926 721 782 815 819 3,137 3,426 3,595 3,757 Margin 38.7% 38.4% 36.9% 36.4% 36.5% 37.6% 38.1% 37.1% 37.3% 38.0% 38.0% 38.7% 37.9% 38.1% 39.0% 39.4% 39.7%

SG&A 1,692 1,759 1,647 1,758 485 484 480 489 1,939 492 495 502 514 2,003 2,108 2,178 2,247

Reported Operating Income 1,219 1,215 921 714 176 265 281 265 987 229 287 312 305 1,134 1,318 1,416 1,510 Margin 16.2% 15.7% 13.2% 10.5% 9.7% 13.3% 14.1% 13.0% 12.6% 12.1% 14.0% 14.8% 14.1% 13.8% 15.0% 15.5% 16.0%

Exceptional Items - 41 56 73 11 4 3 7 25 5 3 2 - 10 - - -

Core Operating Income 1,219 1,257 977 787 187 269 284 272 1,012 234 290 314 305 1,144 1,318 1,416 1,510 Margin 16.2% 16.2% 14.0% 11.6% 10.3% 13.5% 14.2% 13.4% 12.9% 12.3% 14.1% 14.9% 14.1% 13.9% 15.0% 15.5% 16.0%

D&A 291 307 327 361 96 97 97 96 386 99 99 99 99 396 405 415 424

EBITDA 1,509 1,564 1,304 1,147 282 367 381 368 1,398 333 389 413 404 1,540 1,723 1,831 1,934 Margin 20.1% 20.2% 18.7% 16.9% 15.6% 18.4% 19.1% 18.1% 17.8% 17.5% 18.9% 19.6% 18.7% 18.7% 19.6% 20.1% 20.4%

Net Interest 121 127 127 130 34 35 34 33 135 35 35 34 31 135 114 105 95 Other Income/Expense 2 5 7 105 90 0 - - 90 - - - - - - - -

Pre-Tax Income 1,100 1,094 801 689 232 231 246 232 942 194 252 278 274 999 1,204 1,311 1,414

Taxes 266 327 205 180 60 67 69 65 261 54 71 78 77 280 337 367 396 Effective Rate 24.2% 29.9% 25.6% 26.2% 25.7% 28.9% 28.0% 28.0% 27.7% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0%

Minority Interest - - - - - - - - - - - - - - - - -

Continuing Income 834 767 596 508 172 164 177 167 681 140 182 200 197 719 867 944 1,018

Adjustments (83) (11) (18) - - - - - - - - - - - - - -

Headline Income 752 756 578 508 172 164 177 167 681 140 182 200 197 719 867 944 1,018

DWAC 173 169 159 157 157 158 158 158 158 157 157 157 156 157 155 154 152

Headline EPS 4.33 4.48 3.63 3.25 1.09 1.04 1.13 1.06 4.32 0.89 1.16 1.28 1.26 4.58 5.58 6.15 6.70 Yoy 19% 3% -19% -11% 72% 38% 36% 3% 33% -19% 11% 14% 19% 6% 22% 10% 9%

GAAP EPS - Diluted 4.33 4.48 3.63 3.25 1.09 1.04 1.13 1.06 4.32 0.89 1.16 1.28 1.26 4.58 5.58 6.15 6.70


54

Case Study: Dover

We’ve seen a positive inflection in DOV’s organic growth (defined as growth ex-FX and M&A) after two years of

declines.

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

e

20

18

e

Organic Growth


55

Case Study: Dover

Similarly, we expect operating margins to expand through 2018 after declining for the last two years.

8%

9%

10%

11%

12%

13%

14%

15%

16%

17%

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

e

20

18

e

Core Operating Margin


56

Case Study: Dover

Combined, we expect DOV’s EPS to grow ~33% this year and 6% next year.

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

e

20

18

e

Headline EPS Growth


57

Case Study: Dover

DOV has seen its NTM P/E multiple re-rate over the last two years, from ~15x in Sept 2015 to ~21.5x today.

12

14

16

18

20

22

24

Sep

-15

Dec-1

5

Ma

r-16

Jun

-16

Sep

-16

Dec-1

6

Ma

r-17

Jun

-17

Sep

-17

NTM P/E 1Y Median 5Y Median


58

Case Study: Dover

Share Price Performance & MS Ratings Changes

0

20

40

60

80

100

120

Jun

-11

Sep

-11

De

c-1

1

Mar

-12

Jun

-12

Sep

-12

De

c-1

2M

ar-1

3

Jun

-13

Sep

-13

De

c-1

3M

ar-1

4

Jun

-14

Sep

-14

De

c-1

4M

ar-1

5

Jun

-15

Sep

-15

De

c-1

5

Mar

-16

Jun

-16

Sep

-16

De

c-1

6M

ar-1

7

Jun

-17

Sep

-17

DOV Share PriceInitiate UW

Upgrade to EW

Upgrade to OW

Downgade to EW

Upgrade to OW


59

Price

Target

$97 Aligned with our Base Case scenario

Bull

$110

20.0x Bull

Case NTM

EPS of $5.50

Assuming a mid-cycle re-acceleration and robust recovery in Energy,

we believe DOV will see 8% organic growth in 2017e and +7% in 2018e,

driven by a recovery in NA Energy & Fluids. We model 240bps cumulative

margin expansion over 2017/18e, mainly on restructuring payback and

volume recovery. Our 20.0x multiple assume partial contraction from

current 10Y highs, but is largely in line with EE/MI peer average.

Base

$97

19.0x Base

Case NTM

EPS of $5.08

Assuming a mid-cycle re-acceleration and recovery in Energy, we

believe DOV will see 7% organic growth in 2017e and +4% in 2018e, driven

by a recovery in NA Energy & Fluids. We model 230bps cumulative margin

expansion over 2017/18e, mainly on restructuring payback and volume

recovery. Our 19.0x multiple assumes DOV trades in line with EE/MI peer

average.

Bear

$58

15.0x Bear

Case NTEM

EPS of $3.84

Assuming a recession one third as severe as 2009, we embed 4%

organic sales for DOV in 2017 and flat for 2018/2019. Our Bear Case

model assumes 10bps margin expansion vs. 2016. Our 15.0x multiple

assumes contraction towards 5Y lows. Source: Morgan Stanley Research, Thomson Reuters.

Why Overweight?

Dover ex-Energy will be a less cyclical portfolio, levered to growth

end markets with an increasing penetration of recurring revenue.

This should support a premium valuation to the broader EE/MI

group.

Dover is transitioning to Cash EPS. We this to add ~95c of

earnings power in 2018 (~70c post Wellsite-spin). The market

generally doesn’t back out amortization of "cash reporters" so the

shift should provide positive momentum into 2018.

Dover continues to trade at a premium to the group on P/E.

However, we believe the attractive Price/FCF multiple supports the

stock at these levels, with the stock trading at a discount to the

group.

Potential Upside Catalysts

Announcements surrounding the strategic review of Wellsite. Dover

is currently reviewing the Wellsite portfolio of the company's Energy

business. Any announcements should be positive catalysts for the

stock.

Transition to Cash EPS. Dover is shifting to cash EPS in 2018

which should add ~95c of earnings power. We do not expect this to

be backed out of the multiple.

Risks to Achieving Price Target

Industrial Slowdown. DOV ex-Energy would still have higher-than-

average cyclicality. As such, the portfolio is still susceptible to a

slowdown in global industrial markets.

EMV Air Pocket. Several companies have highlighted an air pocket

in EMV-driven retail fueling demand. Any further extension of this

air pocket (beyond current 1H18) could weigh on the stock.

$97.00 (+5%)$92.04

$58.00 (-37%)

$110.00 (+20%)

0

20

40

60

80

100

120

Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18

$

WARNINGDONOTEDIT_RRS4RL~DOV.N~ Price Target (Sep-18) Historical Stock Performance Current Stock Price

Dover (DOV): Overweight, $97 Price Target


60

EE/MI Risk Rewards

currentprice

21%15% 15%12%

6% 5% 3% 3%

14% 14%8% 5% 4% 2% 1% 1%

-1% -3% -5% -8%-2% -6% -10%-11%

PT

BEAR

BASE

BULL

-100%

-80%

-60%

-40%

-20%

20%

40%

60%

80%

100%

WCC(OW)

JCI(OW)

HUBB(OW)

ETN(OW)

PH(OW)

IR(OW)

DOV(OW)

HON(OW)

FLOW(EW)

REVG(EW)

HDS(EW)

PNR(EW)

RBC(EW)

FTV(EW)

SWK(EW)

EMR(EW)

FAST(EW)

AME(EW)

ROK(EW)

ITW(EW)

GWW(UW)

LII(UW)

MMM(UW)

WSO(UW)

UTX(++)


61

DISCLOSURE SECTION


62

Morgan Stanley is acting as financial advisor and providing financing services to United Technologies Corp.("UTC”) in connect ion with its definitive agreement to acquire Rockwell Collins, Inc. (“Rockwell”), as announced on September 4, 2017. The proposed transaction is subject to approval by Rockwell’s shareholders, regulatory approval and other customary closing conditions. This report and the information provided herein is not intended to (i) provide voting advice, (ii) serve as an endorsement of the proposed transaction, or (iii) result in the procurement, withholding or revocation of a proxy or any other action by a security holder. UTC has agreed to pay fees to Morgan Stanley for its financial services, including transaction fees and financing fees which are contingent upon consummation of the transaction. Please refer to the notes at the end of this report.

Morgan Stanley & Co. International plc (“Morgan Stanley”) is acting as financial advisor and providing financing services to Suez S.A. Environment ("Suez Environment ") together with Caisse de Depot et placement du Quebec (“CDPQ”) for the proposed acquisition of GE Water & Process Technologies (“GE Water”) from General Electric Company as announced on 8th March 2017. The transaction is subject to regulatory and other customary closing conditions.

Suez Environment has agreed to pay fees to Morgan Stanley for its financial services, including transaction fees and financing fees that are subject to the consummation of the transaction. Please refer to the notes at the end of the report.


63

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64

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65


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(as of August 31, 2017)

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66


Stock Price, Price Target and Rating History (See Rating Definitions)

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67

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