Yahoo Finance

The industrial sector hovering near record highs, and according to our next guest, there are pockets of strength that can run even further. And they might not be the traditional industrial names you might think of or even maybe you've heard of before. Joining us now for the Yahoo Finance playbook is Jonathan Sacerda, a CFRA Research Analyst. Thanks for being here, Jonathan.

Thanks for having me here.

Let's quickly just talk about industrials first of all and the strength that we have seen. You know, what's been driving that and then and now that we are in a rate cutting cycle, what does that imply for how they're going to continue to do?

Right, so a lot of it has been driven by those rate cut expectations. Now, going into the beginning of this year, we expected a bit uh earlier rate cuts to be taking place, but that 50 basis cut really was a catalyst to drive this sector forward. As you said, last year the sector is up 18%, this year it's up 20% year to date. Um so there's really a high expectations looking really to 2025 as far as a recovery in sales and earnings growth and really recovery in capital spending towards large capital goods like uh machinery and and stuff like that. Um but I mean, with that, the flip side of it is that valuation has kind of uh gone up a bit, right? Multiples have increased. Right now industrials are trading at 24 and a half times forward earnings. This is a premium to S&P 500, a premium to its long-term average. So we think that it's really would be prudent for investors to be a bit more selective in this space and be a bit more discerning as far as where they're allocating their capital.

I know one big name that everybody knows, um, John Deere. You cut that, you were on a hold, you cut that went to a sell. Was part of your thesis valuation there?

No, that was really a sub-industry call. Uh it's really just a continuation in the deterioration of the fundamentals within ag and farm machinery. Right? Like there's been record harvest yields across a number of different crops and this has only helped to balloon supplies. Prices have suffered quite significantly. Now last quarter, Deere & Co, it was pretty positive. They reiterated the profit guidance while peers cut it quite dramatically. But we think there's a high risk looking to the second half of this year that they're going to end up cutting it. Like prices continue to deteriorate, and while lower interest rates are going to be a tailwind, they can't outperform those lower commodity prices, right? Farm at the end of the day, farmer incomes are decreasing and that's going to hurt Deere & Co.

And now you also have this FTC investigation into their repair system, um, and network. Is that a material risk or you know, it sounds like you don't think they're going to do well regardless of the outcome of that investigation.

Right. We don't think it's going to be a material risk, nothing existential for Deere & Co. This has kind of been a a uh a controversial point for them for a while now. It kind of comes and goes whenever it kind of enters a spotlight, but we really think that uh really the the main thesis as far as to stay away from shares is just a deteriorating uh macro backdrop for for farming ag.

And Jonathan Caterpillar, why is that a hold? And what would it take to get you more bullish?

More bullish. So Caterpillar is exposed to some favorable tailwinds. You have the power generation business, uh serving kind of the the backup power market for data centers, right? A lot of spending going into the AI theme, or one of the uh you know, they want to make sure they have their backup power systems. Caterpillar really serves that role, but this is not a majority of their business. Um, we're a bit mixed just given geographical exposure, right? The majority of their sales exist outside the United States. There's a lot of geopolitical risks right now in the Middle East, in Europe. So we're a bit more mixed on that. I'd say just clarity, um, and the second half of this year or actually the the first half of next year really, that construction spending is coming back, right? So non-residential has been kind of slowing down a bit, residential has been slowing as well, but I we'd like to see actually not just expectations, but like tangible results.

It's had a nice run, Jonathan.

It's had a great run. We we had a buy recommendation. We had a buy recommendation, but then at a 60% run from when we upgraded, we're like, okay, there's just less upside, right? And and since then it's entered kind of a period of volatility up and down, but um, we just need to see a bit more um, in terms of fundamental results these next few quarters.