Industrials Sector Stock Presentation

Saniya Mussinova

Daniel Pierce

Michael Royer

Nicholas Stuart

Zane Stephens

Sector Recap

Weighting the sector

12 bps over S&P

Adding 25 bps to

portfolio

Industrials have

outperformed S&P

Remain cautiously

optimistic going

forward

Current Holdings

(DHR) 3.10%

(FLS) 3.94%

(GD) 4.05%

11.09%

Stock Recommendations

Sell 405 bps of GD

Buy 105 bps of DHR

Buy 325 bps of UTX

Hold 394 bps of FLS

Flowserve Corp

Market cap: $7.38 billion

Current Price: $117

Target Price: $134 (15% upside)

Recommendation: Hold

Recent Developments:

◦ Quarterly cash dividend of $0.32 per share

Positives

Bookings and aftermarket growth

Stock price has grown by 35% in 1

year

Repurchasing plan of up to $2 mln

shares

Segment restructuring

Good purchasing decisions:

◦ Purchase of FEDD Wireless (Intelligent

Process Solutions) in 2011

◦ Purchase of Valbart in 2010

Stable growth in emerging markets

Q4 anticipating strong shipment –

bring down backlog

Negatives

Recent increase in backlog (8.4% vs prior year)

Decrease in margins

7.2% increase in DSO (AR/Sales) over prior year quarter

Long cycle market continues to be choppy and competitive

Nuclear projects being delayed: nuclear power outlook under scrutiny as countries re-evaluate nuclear strategy

Recommendation: Increase 105 BP

Current Price: $53.72

Target Price: $60.00 (11.7% upside)

Overview:◦ Designs, manufactures and markets professional,

medical, industrial and commercial products and services

◦ Operates in five segments: Test & Measurement; Environmental; Life Sciences & Diagnostics; Dental, and Industrial Technologies

◦ Outperforming the S&P 500 Industrials Group YTD

◦ Growth derives from both segment core expansion and frequent external acquisitions

DHR Relative to Sector

0

0.5

1

1.5

2

2.5

P/Trailing E P/Forward E P/B P/S P/CF P/EBITDA

High

Low

Median

Current

DHR Overview

Positives:

◦ Increasing sales in foreign markets, notably those with growing economies

◦ Experienced management knowledgeable in the Danaher Business System, a proven lean production method

◦ Strong sales and margin growth, including double digit core growth in Industrial Technologies and Test & Measurement segments. Margins now above 20% in both segments

◦ With purchase of Beckman Coulter, decreased exposure to potential economic decline

Manufactures and markets biomedical testing

instrument systems, tests and supplies

Operates in two segments:

◦ Clinical Diagnostics - Products physicians use to

diagnose disease, make treatment decisions and

monitor patients. Approx. 87% of revenues

◦ Life Science - Products used by scientists to study

complex biological problems, including the causes

of disease, identifying new therapies and testing

new drugs. Approx. 13% of revenues

DHR Overview

Concerns:

◦ Other companies are acquiring former Danaher managers, possibly acquiring key information about Danaher’s vital lean production system

◦ Over 70% of sales growth in the last 5 years has come from acquisitions

◦ With the $6.8 billion purchase of Beckman Coulter, Danaher is reducing funds for acquisitions from roughly $2 billion to $300 million for remainder of year

Company Overview

Aerospace•Designs, manufactures and outfits mid- and

large-cabin business-jet aircraft and provides

maintenance, refurbishment, outfitting and

aircraft services for a variety of business-jet

customers.

Combat Systems•Provides design, development, production, support and

enhancement of tracked and wheeled military vehicles,

weapons systems and munitions for the United States

and its allies.

Marine Systems•Designs, builds and supports submarines

and surface ships for the United States

Navy and commercial ships for Jones Act

customers

Information Systems and Technology•Provides technologies, products and services that support a range of

Government and commercial digital-communication and information-

sharing needs

Sector (S&P): Industrial

Industry (S&P): Aerospace,

Defense

Market Cap: 27.27B

Shares Outstanding: 373M

Avg. Daily Vol: 2.05M

YTD Return: 2.92%

52 Week Range: 55.46 – 78.27

Dividend Yield: $0.47 (2.57%)

Business AnalysisSegment Revenue % Revenue Earnings % Earnings Operating Margin

Aerospace 5,299 16.32% 860 21.35% 16.23%

Combat Systems 8,878 27.35% 1,275 31.65% 14.36%

Marine Systems 6,677 20.57% 674 16.73% 10.09%

Information Systems 11,612 35.77% 1,219 30.26% 10.50%

32,466 100.00% 4,028 100.00%

FY 2010 (Millions)

Business Analysis

Strengths Diverse business segments

Incumbent status with certain products

Success with acquisitions

Improving economy

Weaknesses Uncertain defense spending

Fixed price contracts

High energy costs

Slow economic recovery

GD VS Industry VS Sector

DCF ValuationGeneral Dynamics (GD)

Analyst: Michael Royer Terminal Discount Rate = 10.5%

5/22/2011 Terminal FCF Growth = 2.75%

Year 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E

Revenue 34,094 35,803 37,577 39,043 40,643 42,188 43,664 44,974 46,099 47,251 48,551

% Grow th 5.0% 5.0% 3.9% 4.1% 3.8% 3.5% 3.0% 2.5% 2.5% 2.8%

Operating Income 4,035 4,283 4,476 4,412 4,593 4,725 4,847 4,992 5,163 5,292 5,438

Operating Margin 11.8% 12.0% 11.9% 11.3% 11.3% 11.2% 11.1% 11.1% 11.2% 11.2% 11.2%

Interest and Other 170 179 169 176 183 190 196 202 207 213 218

Interest % of Sales 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5%

Taxes 1,198 1,272 1,335 1,313 1,367 1,406 1,442 1,485 1,536 1,575 1,618

Tax Rate 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 31.0%

Net Income 2,666 2,832 2,972 2,923 3,043 3,129 3,209 3,305 3,419 3,505 3,601

% Grow th 6.2% 5.0% -1.6% 4.1% 2.8% 2.5% 3.0% 3.5% 2.5% 2.8%

Add Depreciation/Amort 648 680 733 664 691 717 742 765 784 803 825

% of Sales 1.9% 1.9% 2.0% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7%

Plus/(minus) Changes WC (534) (435) (451) (449) (491) (473) (451) (398) (340) (348) (394)

% of Sales -1.6% -1.2% -1.2% -1.1% -1.2% -1.1% -1.0% -0.9% -0.7% -0.7% -0.8%

Subtract Cap Ex 511 501 451 664 691 717 742 765 784 803 825

Capex % of sales 1.5% 1.4% 1.2% 1.4% 1.4% 1.4% 1.4% 1.4% 1.5% 1.5% 1.5%

Free Cash Flow 2,269 2,576 2,802 2,474 2,551 2,657 2,758 2,907 3,080 3,157 3,208

% Grow th 13.5% 8.8% -11.7% 3.1% 4.1% 3.8% 5.4% 5.9% 2.5% 1.6%

NPV of Cash Flows 16,596 51%

NPV of terminal value 15,669 49% Terminal Value 42,526

Projected Equity Value 32,265 100%

Free Cash Flow Yield 8.06% Free Cash Yield 7.54%

10-year

Current P/E 10.6 9.9 9.5 Terminal P/E 11.8 16.0

Projected P/E 12.1 11.4 10.9

Current EV/EBITDA 6.1 5.8 5.5 Terminal EV/EBITDA 6.9 9.6

Projected EV/EBITDA 7.0 6.6 6.3

Shares Outstanding 385

Current Price 73.03$

Implied equity value/share 83.75$

Upside/(Downside) to DCF 14.7%

Debt 3,203

Cash 2,613

Cash/share 6.78

Multiples Valuation

Absolute

Valuation High Low Median Current

Your

Target

Multiple

Target E,

S, B,

etc/Share

Your

Target

Price

P/ Forward E 19.7 6.5 15.1 10.1 12 7.11 85.32$

P/S 1.8 0.6 1.2 0.8 0.95 90.92 86.37$

P/B 4.7 1.6 3.1 2 2.2 40 88.00$

P/EBITDA 12.3 3.93 9.52 6.12 7 12 84.00$

P/CF 18.2 5.5 13.9 8.6 10.5 8 84.00$

Average Multiples Target Price = $85.54

DCF Target Price = $83.75

Weighted Average Target Price = (.80 * 83.75) + (.20 * 85.54) = $84.11 (15.17% upside)

Recommendation

Deciding Factors

High energy costs

Government dependence

Slow economic recovery

Sell 405 Basis Points of

General Dynamics

UTX Overview

Aerospace & Defense

Beta 1.01

Dividend yield 2.2%, very few in industry

UTX outperformed the S&P by 6.7%

History of steady growth in earnings and dividends over the past 10 years

Strong balance sheet

◦ Cash represents 7% of assets

◦ Long-term debt 30%

Segments

Pratt- major supplier of jet engine to commercial, business and military aircraft, 25% operating profit, 52% international

Otis-world’s largest maker of elevators and escalators, freight mover, 32% operating profit, 82% international

Carrier- #1 marker of HVAC systems- provides installation, service, parts, 25% operating profit, 52% international

Sikorsky- largest manufacturer of helicopters, aftermarket products and services, 9% operating profit, 33% international

UTC Fire & Security- global provider of fire and safety security products, 9% operating profit, 84% international

Hamilton- advanced industrial products, power generation, propeller systems, environmental control units, etc, 12% operating profit, 49% international

1 Year Price Movement

5 Year Price Movement

Risks

Double dip recession

Sustained rise in the dollar

Increasing prices of energy dampening

airline industry

Lack of recovery in housing sector,

residential and commercial construction

Insider selling as of April

High price/book ratio

Historic trends

For the past 10 years, annual

compounded rates were:

◦ Sales growth of 7.4%

◦ Income from continuing operations growth of

9.2%

◦ 10.3% Earnings per share

◦ ROC 16.2%, S&P average 15.8%

◦ FCF growth of 9.2%, S&P average 6.7%

UTX vs. competitors

Future Catalysts

Large backlogs of commercial aircraft from Boeing and Airbus hope to provide steady sales and production levels the next three years,

Development of Boeing 787 and Airbus 350

Continued strong growth of emerging markets

UTC Fire & Security: purchased GE Security in March 2010

Increased OEM demand, aerospace aftermarket recovery

Developing CH-35K for USMC

Current Financials

Diluted EPS 5.36

Last year’s sales growth- 10%

TTM P/E is 17.78, industry average 28.27

ROE 22.55%, average of Manufactured Industrials is 7.33%

Last quarter EPS $1.11, beating $1.07 estimate

Current ratio 1.3, well below Aerospace average 2.8

Days of sale inventory 78 days, 123 industry

(TTM) UTX BA GE

Qtrly Rev Growth 10.80% -2% 6.20%

Revenue 55.63B 64B 152.46B

Gross Margin 28.21% 19.14% 37.76%

Operating Margin 14.35% 7.06% 13.31%

Diluted EPS 4.92 4.53 1.20%

P/E 17.40 16.66 15.94

Valuations

DCF using consensus estimates, updated

earnings

◦ $100

EBITDA value driver, multiple 9x

◦ $96

Recommendation:

◦ BUY 325 basis points UTX

Questions?

Appendix A: Danaher DCF

Appendix B: Flowserve DCF

Appendix C: UTX DCF