Industrials Sector Jason Kraynak and Wade Guzdanski

Agenda  Overview  Business Analysis  Economic Analysis  Financial Analysis  Valuation Analysis  Recommendation

Overview

Industrials  Capital Goods  Aerospace & Defense, Construction & Engineering, Electrical Equipment, Building Products, Machinery, Trading & Distributors  Commercial Services & Supplies  Commercial Printing, Data Processing,  Transportation  Air Freight & Logistics, Airlines, Marine, Road & Rail, Transportation Infrastructure  Market Cap of $1.55 Trillion

Industrials Avg. % of S&P 500 Source: Factset

SIM Portfolio Weight – 6/23/2013  Industrials account for 10.7% of S&P 500, portfolio is currently underweight 234bps

Current SIM Holdings  Shares in Danaher Corporation were sold as part of move to reduce portfolio to $10M prior to fiscal year-end

Sector Industries  88% of sector is comprised of three industries: Electronic Technology, Producer Manufacturing and Transportation

Largest Companies

Industrials Performance

Business Analysis

Industrials Life Cycle  Industrials sector is in the “Maturity” phase  Slow stable growth, consistent with overall economy  Consistent returns and cash flow  Low number of new entrants  Dominated by a few large companies

Business Cycle Impact  As the economy improves, companies increase capital spending in response to higher demand for products  Leads to expansion in production capacity  Global sector  Significant influence from domestic and international economies  Growth focused in emerging markets

Catalysts & Risks  Catalysts  Europe coming out of their recession  Turnaround in China  Growth in emerging markets  Risks  Lower government spending  Strengthening US Dollar  Uncertainty regarding monetary policy  Slow global growth forecast

Porter’s Five Forces

Economic Analysis

Industrials Drivers  High Correlation to overall equity market  Production & Manufacturing  GDP  Unemployment  Crude Oil  Housing

Industrials & S&P 500 highly correlated 10 Years Industrials S&P 500

Industrials & S&P 500 highly correlated 5 Years Industrials S&P 500

Industrials & S&P 500 highly correlated 2 Years Industrials S&P 500

Industrial Production  Measures real output of manufacturing, mining, and electric and gas utilities  Industrials sector accounts for the bulk of the variation  Manufacturing very soft based on May data.  Excluding motor vehicles, manufacturing rose only 0.1% in May  Capacity utilization decreased to 77.6% in May from 77.7% in April Data source: Haver Analytics

Durable Goods Orders Data source: Haver Analytics  Reflect new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods  Extremely volatile  Up 3.6% in May  Transportation up 10.2%, making up most of the gains

ISM Manufacturing Index Data source: Haver Analytics  Survey of 300 manufacturing firms: employment, production, new orders, deliveries, inventories  >50 = expanding <50 = contracting currently 50.9  Strength from new orders and export orders  Weaknesses from employment, inventories, and prices  Slow growth

GDP Data source: Haver Analytics  Revised down to 1.8% from 2.4% led down by personal consumption  Headline inflation at 1.2%  Economic Growth marginally positive in Q1 with low inflation  What will the Fed do?

Unemployment Data source: Haver Analytics

Crude Oil – Highly Correlated 5 Years

Housing – Existing Home Sales Data source: Haver Analytics  Up 4.2% to annual sales rate of 5.18 million, highest since late 2009  Median price up 8.4% in May to $208,000 mean $255,300

Housing – New Home Sales Data source: Haver Analytics  Up 2.3% to annual rate of 454,000  Median price up 8.3% in May to $271,600 mean $330,800

Housing – Housing Starts Data source: Haver Analytics  We need equipment, tools, and material to build!  Thank you Ben Bernanke!

Financial Analysis

Revenue Growth Slow & In-Line with S&P 500  5 Year CAGR: Industrials Sector 2.7%, S&P %

Margin Growth Lags S&P 500  Industrials sector operating margin lags S&P 500  5 Year CAGR: Industrials Sector -0.7%, S&P %  Mixed results in net profit margin  5 Year CAGR: Industrials Sector 2.5%, S&P %

Significant R&D and Capex Spend  Increase in R&D spend as a percent of sales  5 Year CAGR: Industrials Sector 2.2%, S&P %  Capital intensive industry, capex as a percent of sales is increasing but trailing S&P on percent growth  5 Year CAGR: Industrials Sector -0.7%, S&P %

ROE is a Concern, but Rebounding  Industrials sector operating margin lags S&P 500  5 Year CAGR: Industrials Sector -2.2%, S&P %  Mixed results in net profit margin  5 Year CAGR: Industrials Sector 7.9%, S&P %

Consistent Generated of FCF, Lags S&P 500  5 Year CAGR: Industrials Sector -1.1%, S&P %

Valuation Analysis

Industrials Valuation

Recommendation

 Currently -234bps underweight  We recommend no change in weighting of industrials  Reasons for concern  Slow global growth  GDP forecasts  Economy is still early in recovery phase  Foreign political uprisings  Low growth potential – valuation suggests sector is inline  Why we may be wrong  Recent housing recovery  Possible energy independence (lower production costs = higher margins)  Faster economic expansion  Consumer sentiment

Questions?