Out Of Favor

Dec. 21, 2004
As dot.coms and megacorporations command the investment spotlight, manufacturers crave -- and deserve --more attention.

In a dark corner of a proud company behind a powerful, Internet-linked computer sits a junior employee. He listens carefully to the office buzz. He hears how the executives obsess over the company's stock price and agonize over quarterly earnings. The fixation is infectious. Pretending to focus on company tasks, the employee logs onto the Web and begins surfing chatrooms and financial wires for tips and news. Then he dials into Web brokerage Datek Online. Targeting the highfliers, he buys and sells 15, 50, 500 times a day. The surreptitious day trader dreams of millions -- and loses thousands. One thing is certain: If he works for a manufacturer, he avoids his own company's stock. Makers of capital equipment, chemicals, caskets, and just about every other product not covered by the high-tech umbrella are being ignored as both individual and institutional investors target growth stocks. Manufacturing equities, even when bolstered by low debt and high quality, are out of favor on Main Street and Wall Street. Companies have scrambled to upgrade equipment, improve technology, make tough decisions, and streamlined operations in an effort to gain some respect in the investment community. Yet they remain the many, the ignored, and the forgotten. Their stock prices are flat -- or worse, have declined. Their price-to-earnings ratios languish well below average. And their analyst coverage has all but disappeared. "While Internet companies are very exciting and transforming our economy, even our culture, what you find is that many other traditional companies are left in the shadows," observes John W. Hyland Jr., a partner at New York investment firm McFarland Dewey & Co. LLC. He's not talking about Cisco Systems Inc., General Electric Co., Flextronics International Ltd., or a handful of other fast-growth or giant manufacturers that have managed to harness investor attention. They are the exceptions. No, Hyland has in mind companies with well-known manufacturing names such as Benjamin Moore & Co., Arvin Industries Inc., Ingersoll-Rand Co., Liz Claiborne Inc., and Toro Co. These companies boast good growth stories and solid plans for the future. But many investors just don't seem to care. Indeed, small and large manufacturers, with market capitalizations ranging from $30 million to $8 billion, are frustrated. "Getting attention on the Street is difficult," complains Bart C. Shuldman, president and CEO of $52 million Transact Technologies Inc., a manufacturer of printers. "I spend 20% to 25% of my time on the phone, at different meetings trying to get introduced to people and to build interest," he reports. The frustration of big manufacturers is revealed in the annual reports of a number of IndustryWeek's 100 Best-Managed Companies. Earnings at automotive-parts manufacturer Arvin Industries Inc., for instance, have doubled since 1993 thanks to reductions in labor and selling costs. In 1998 the Columbus, Ind., corporation counted profits of $78 million on sales of $2.5 billion. Its stock price, however, has failed to reward that performance. After reaching a high of $44 last May, it hovers in the mid-$20s. Its price-to-earnings ratio stands at 7.3 -- well below the P/E ratios of S&P 500 companies, which average about 25. The numbers at Ingersoll-Rand tell a similar story. In 1998 the Woodcliff Lake, N.J., manufacturer of construction and industrial machinery achieved its fifth consecutive year of record sales ($8.3 billion) and earnings ($509 million). But its stock price failed to reflect its performance. Although it reached $73 in the second quarter of 1999, the stock price recently fell back to $47. At 13.4, its P/E ratio is equally disappointing. What's Behind It Experts offer several explanations for the Street's ennui. They fault industry's image problem. At least at first glance, production seems boring. Manufacturers that have thrived selling to other businesses are especially unprepared for the Internet's impact on the investment world. Their Web sites are clunky, designed for customers and not for the securities analysts who now turn first to the Web for information. There are other reasons. The Street is starting to place a premium on something called the "price-to-imagination" multiple and shoving the traditional P/E ratio to the side. Hoping to pick the handful of winners that will survive the dot.com mania, traders are willing to pay 100 times a start-up's revenues even though its earnings prospects are uncertain at best. What's more, there's a yawning generation gap between hot-shot analysts practicing the latest in M.B.A. thinking and the gray-haired veterans who run many of the manufacturing companies. Some middle-aged executives have stiffened up when faced with a gang of fast-talking Young Turks shooting tough questions during a presentation. Even worse are the manufacturers who reinforce the notion that industrial companies make poor investments. "The nature of the problem can be seen in the way some companies look at their pension management," explains Andrew Bischel, a principal at Spare, Kaplan, Bischel & Associates, a $1.5 billion institutional investment advisory firm in San Francisco that concentrates on value stocks. "They expect their managers to perform every quarter and when they don't, there's been a trend toward indexing or other growth-style investing. It's a siren song, and everyone's getting sucked in." The impact can be devastating. Lack of capital forces companies to reject attractive acquisitions, but simultaneously can make them attractive to acquisitive competitors. As customers demand global service, businesses low on cash may need to turn down supplier agreements in Asia or Europe because they can't afford to build the infrastructure. A weak share price also hurts recruitment as more employees are compensated in options. Toro's Tale What's a public company to do? That question swirled around the head of Kendrick B. Melrose, chairman and CEO of Toro, not too long ago. "There we were, an exciting company, doing Wow! things, and no one was listening. We could see an ebbing of interest from institutional investors," he complains. Melrose suspects the dot.com companies have captured their attention. He also blames consolidation in the financial industry. Toro cultivated relationships with analysts, but it seemed that every time it interested one, her brokerage would merge with another firm, and she would end up leaving. Toro held big Manhattan meetings targeting members of the New York Society of Security Analysts. They failed to pay off. "People thought it was an opportunity for a free lunch," remembers Melrose. So the Bloomington, Minn., manufacturer stopped holding the large, expensive meetings where it gave canned presentations and started focusing on individual analysts. Now it sets up one-on-one meetings during which executives can explain Toro's investments in technology. It arranges for analysts to attend trade shows and to meet golf-course architects and other customers. Toro has discovered a number of interested listeners in regional investment houses outside of New York. And to raise its visibility, Toro teams up with such high-profile golf courses as The Country Club in Brookline, Mass., which hosted the 1999 Ryder Cup, to showcase its irrigation-system prowess and other grass-tending innovations. Melrose does not see Toro becoming a dot.com company, but the manufacturer has invested in a promising high-tech start-up. It put money into ProShot Golf Inc., a firm using global-positioning-satellite technology to improve golf-course management and play. One of ProShot's innovations allows players to check a television monitor on their golf cart for pin distance, wind speed, and other data on which to base club use. Executives are considering other more radical measures that could impress investors -- such as outsourcing segments of production. Still, Melrose remains dissatisfied with the Street's coverage. "It could be better," he admits. "We're not drumming up as many potential interested parties, but the batting average is better." Times have changed since Melrose's parents, who both worked as stockbrokers, used to cover companies. "Their model was, let the numbers speak for themselves. If a company did well then its stock would do well," he recalls. No one managed earnings by quarter, and no one was afraid that if their estimates were off by a penny at the end of one quarter their earnings would fall by 20%. Impatience Even in the 1980s manufacturing leaders with fundamentally sound businesses but foundering stock prices used to be able to wait it out. Today, patience appears to have vanished. "You might have been more aggressive in investor relations or advertising, and that would shorten the time it took investors to recognize you, but ultimately you would be recognized," observes Lynn Morgen, cofounder of New York investor-relations firm Morgen-Walke Associates Inc. "Companies can't count on that anymore. There's just too much product out there." High-tech start-ups emerging from Silicon Valley, Boston, Austin, and other centers of invention account for some of the glut. So do foreign companies that see a U.S. listing as essential to business in the next century. When US$5.3 billion German chemical manufacturer Celanese AG split off from Hoechst AG in October 1999, it listed on the New York Stock Exchange as well as in Frankfurt. "We listed in New York because this was essential to unlock value for our shareholders," explains Celanese CEO Claudio Sonder. To recapture attention now spent on new listings, smart manufacturers are making changes. Ingersoll-Rand, for example, amended its financial reporting to better capture the nature of its business. It launched an advertising campaign and the Ingersoll-Rand Senior Golf Tour Championship to build awareness in the financial community, as well as with the public. A few small manufacturers have actually gone private, but for most that remains a poor option because of the capital-intensive nature of production. Companies also are looking abroad for alternatives. Thanks to the introduction of the euro, the common currency in 11 of the 15 European Union nations, foreign companies can list on one exchange, but trade in the same currency on several. Even better, European investors are known to seek value and companies with track records. If these sorts of initiatives fail to pay off in a rising stock price, executives must begin asking themselves another round of tough questions. Is there a reason to be a standalone public company? Is there a division that is an impediment to investors' attention? Do I feel so strongly enough about this company's prospects that I am willing to take half my compensation in stock? "Investors are looking for reasons not to own a stock; you don't want to give them one," warns Morgen. In the meantime, some analysts predict a waning of interest in Internet stocks and the largest blue-chip corporations in favor of value investments. Impatience with dot.com companies is growing. As Internet exploiter Amazon.com expands beyond books into other product lines, some traders wonder how much longer it will take for the company to become profitable. One prediction suggests that Amazon's stock price will plummet once it earns money because people will finally be able to conduct a real valuation. When it comes to the megacorporations, the other investment in favor, analysts also see weaknesses emerging. The number of companies sustaining unblemished growth is narrowing. At the top tier of the marketplace, only three companies -- Microsoft Corp., GE, and Cisco Systems Inc. -- continue to perform at vaulted levels. Their peers have started to disappoint financial communities. These include Gillette Co. and Xerox Corp., which have seen significant stock-price declines. "It's not going to be a general shift from growth stocks to value," predicts Morgen. "Investors are going to cherry-pick, get rid of a few highfliers, and buy more value companies." If a manufacturer has made the right moves, it will be cherry-picked in a dark corner of the corporation where, by the light of a monitor, the employee turned surreptitious day trader, starts buying more company stock.

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