A&C shares up nicely, 4Q05

Mark Koznarek -- Control Engineering, 4/1/2006

The Control Engineering share price index notched an impressive performance during 4Q, up 6% on average. Even more impressive has been the continuation of gains so far in 2006—up 12% more through mid-February. This portfolio of Automation/Control components companies handily outpaced the S&P500, which gained about 5% during the past 4.5 months.

Chart shows that A&C stock prices have performed well despite a moderation in the general manufacturing economy, as broadly measured by the Institute of Supply Management's Purchasing Managers Index (PMI). It was the acceleration of manufacturing activity in the 2003-04 period that propelled the A&C group, but since mid-2004, the PMT index has moderated, indicating a steadier, more sustainable pace of general manufacturing growth.

Not coincidentally, the past year of PMI moderation coincided with the Federal Reserve's efforts to push up short-term interest rates to prevent inflation from becoming more widespread. One recent driver of the A&C share price index has been a growing consensus that the U.S. Federal Reserve is in the "late innings" of interest-rate tightening; companies are now concluding it is safe to go back into the water—with refocus on capital spending and business-building acquisitions.

National Instruments was up 30% in 4Q05. These shares may have anticipated the January earnings release, which showed 17% sales growth, best of the year, and 27% earnings growth. Rockwell Automation rose 12% (and has further rallied through mid-February), as investors were excited over the 10% revenue growth and 25% earnings growth in the quarter, led by 25% growth of the Logix PLC product suite.

Automation & Control product growth is driven by capital spending, so we track spending trends and survey major manufacturing companies annually. Last year, we saw capital spending accelerate across 166 companies. In January 2005, these companies forecast 10% capital spending growth, and, in our July 2005 update, this forecast was increased to 12% growth; 2005 capital spending ended up 13%, ahead of plan.

Initial outlook for 2006 capital spending growth again is robust, with 9% growth forecast for 2006. This ongoing capital spending upcycle provides a favorable environment for healthy revenue growth across the Automation & Control universe in 2006. In particular, we think the outlook is particularly favorable for companies exposed to factory capital spending.

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