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2 Industrial Stock Picks Every Investor Needs in His Portfolio $BA $UNP

Industrials rock right now. Industrial stocks have returned roughly 13% since the first of the year and almost a full percentage point over the last five days. The growth comes after the US GDP gained nearly 3% during the fourth quarter. Investors are optimistic that the trend will continue into 2012. There are only a few sectors to benefit so immediately from a change in GDP – industrials is one of them. Here are some of my favorite picks in this sector and their potential going forward.

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Boeing Company (BA)

The first company on my list is the Boeing Company (BA). In spite of the poor economy last year, Boeing increased its revenues by 7% in 2011. Thanks to an improvement in its operating margins, the company’s net income increased 21%. Most of this growth comes from Boeing’s commercial airplanes business. See, the company has two main businesses – commercial airplanes and aerospace/defense. In 2011, its aerospace/defense business was flat year on year while its commercial airplane deliveries were up 14% – 3% from an increase in the number of deliveries and the rest from price increases.

For 2012, Boeing reports that it has over 1,000 orders already; in comparison, the company had just 477 deliveries in 2011. Included amongst the numbers for 2012 is an agreement between the US and Saudi Arabian governments for the purchase of 84 new planes plus upgrades on 70. Boeing also has an $18 billion deal with the Emirates Airlines, a $19 billion deal with Southwest Airlines and, more recently, a $22.4 billion deal with Lion Air for 230 planes on its plate. Obviously, these orders will be a big boost to its commercial airline segment, which will translate into upside for its shareholders.

Boeing recently traded at $75.08 on a mean one-year target estimate of $84.52. In addition to its upside, the company pays a $1.76 dividend (2.30%) and it is priced low, trading at just 13.24 times its future earnings. Analysts are predicting the company’s earnings will increase by an average of 13.20% a year over the next five years, versus expectations of 12.79% for its industry. Given its existing contracts, I think this number is a bit conservative. Boeing is a buy in my book. Ken Heebner might agree with me. His Capital Growth Management opened a new 200,000 share position in Boeing during the fourth quarter.

Union Pacific (UNP)

As the economy picks up, so too do railroads. Given that Union Pacific (UNP) is one of the primary freight railroads in the US with 31,898 route miles (CSX Corp (CSX) has 21000 route miles), with direct access to all Pacific and Gulf ports, the railroad will likely benefit from the increase.

In 2011, Union Pacific’s revenues increased by 10%. Of this, 8% was attributable to an increase in pricing while 2% was driven by a rise in the number of carloads. In fact, five of its six product transportation segments saw increases in the volume of freight transported. These include agricultural, automotive, chemicals, energy and industrial products. Intermodal was the only segment that did not show an increase. The company is also keeping costs down. Its fuel consumption rate, that is the amount of fuel consumed for every gross ton mile increased only marginally, going from 1.129 in 2010 to 1.131 in 2011. Given the fact that Union Pacific increased its pricing and the volume of carloads but barely elevated its costs, it is fair to say that the railroad has the ability to increase prices without losing customers.

Union Pacific recently traded for $111.53 a share on a mean one-year target estimate of $128.13, In addition to the upside, the railroad pays a $2.40 dividend (2.20% yield) and it is priced low, with a forward P/E of just 12.00. According to Yahoo Finance, analysts are estimating that Union Pacific’s earning will grow by a rate of 16.32% per annum on average over the next five years, versus expectations of 14.76% for its industry.

Union Pacific has plans to expand into Louisiana in order to cater to the higher petrochemical transportation demand there. It is investing $3.6 billion into the business this year to make that happen. Louisiana is home to roughly 10 percent of all the oil reserves in the US. Southern Louisiana in particular is home to the Tuscaloosa Trend, which is one of the primary sources for oil in the State. BP Plc (BP) has 35 natural wells there producing 70 million cubic feet of gas a day. I think this is a great opportunity for Union Pacific. Natural gas prices are down right now. In response, many oil and gas companies are putting all their money in oil. Companies like Exxon Mobil (XOM) are continuing to invest in natural gas, taking the headwind now, to be better positioned when natural gas rebounds. Union Pacific is just setting itself up to be a transportation option when the focus shifts back to natural gas – a very smart play. It is easy to see why Merrill Lynch named Union Pacific as one of its favorite stocks for 2012, while Morgan Stanley included the railroad in its list of “50 for 2015,” published December 15, 2011.

We are bullish about Union Pacific’s peers: CSX Corp and Norfolk Southern (NSC). Both of these stocks trade at a forward PE ratio of 12 and are expected to increase their earnings per share by around 10%. These stocks won’t make you rich but they will help you stay rich. We aren’t greedy. Having a current earnings yield of 8% and increasing this by around 10% annually isn’t bad at all. That’s why Warren Buffett bought UNP’s competitor Burlington Northern Santa Fe in 2009 (see Warren Buffett’s top stock picks). We are long-term bullish about energy prices and increases in oil prices benefit Railroads. We think this trend will continue for the foreseeable future.

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