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Patrick McKeough is one of Canada’s top safe-money advisors. The Wall Street Journal, Forbes and The Hulbert Financial Digest have all recognized his ability to find stocks with hidden value. He is editor and publisher of The Successful Investor, Stock Pickers Digest, Wall Street Stock Forecaster and Canadian Wealth Advisor; inventor of the Quick Profit/Value System and the ValuVesting System™. A best-selling Canadian author, he wrote Riding the Bull, the book that predicted the 1990s stock-market boom.

Three Niche Industrials With Gains Ahead

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Fears of a slowing economy have hurt most industrial stocks in the past few months. Rising prices for raw materials, labor and fuel have also slowed their profit growth.

We aim to limit your risk in this sector by zeroing in on companies with strong brands, reputations and market share. These advantages will let them overcome the recent downturn, and maintain earnings and dividends until the economy improves.

Here are three top examples. All are doing a good job controlling costs and diversifying their businesses. As well, their products help customers cut costs and improve product quality. All three are also attractive in relation to their earnings and sales.

GENUINE PARTS CO. $42 (New York symbol GPC; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 165.3 million: Market cap: $6.9 billion; WSSF Rating: Average) distributes automotive replacement parts to over 4,800 independent outlets in North America. It also operates 1,100 retail stores under the NAPA banner. Automotive parts supply nearly half of its revenue and earnings.

Genuine Parts also distributes industrial replacement parts (30% of revenue), office products (15%) and electrical equipment and supplies (5%).

Most of Genuine Parts’ recent growth has come from its industrial and electrical businesses. Many North American plant operators are investing in automated production equipment, which helps cut their operating costs. Expanding sales at these businesses also help cut Genuine Parts reliance on auto parts for growth.

In the three months ended March 31, 2008, earnings rose 1.6%, to $123.5 million from $121.6 million a year earlier. Per-share earnings rose 5.6%, to $0.75 from $0.71, on fewer shares outstanding. Sales grew 3.8%, to $2.7 billion from $2.6 billion.

Sales at the auto parts division rose 3.5% in the quarter, partly due to acquisitions. However, profit fell 5.4% due to strong price competition plus greater sales of lower-margin items.

Demand for auto parts should grow over the next few months, particularly now that the average car in the United States is over eight years old. Genuine Parts should also continue to benefit from the increasing number and complexity of vehicles.

The company is also fueling its growth with acquisitions of smaller parts distributors that it can easily absorb. These new businesses will help Genuine Parts expand its 5% share of the highly fragmented auto parts market.

Genuine Parts’ strong balance sheet will let it continue to make acquisitions. Its long-term debt of $250 million is less than six months cash flow. It also holds cash of $161.5 million or about $1.00 a share.

The stock trades at 13.3 times its likely 2008 earnings of $3.15 a share, and at just 0.6 times its sales of $65 a share. The $1.56 dividend yields 3.7%.

Genuine Parts is a buy.

SNAP-ON INC. $55 (New York symbol SNA; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 57.6 million; Market cap: $3.2 billion; WSSF Rating: Average) makes hand and power tools for auto mechanics. The company distributes its products through a fleet of franchised vans that visit garages and service shops. This way, dealers can build long-term relationships with their customers. This business supplies 35% of Snap-On’s total revenue.

The company also makes tools and equipment for non-automotive customers, including the construction, electrical and agricultural industries (40% of revenue). Most of the remaining 25% of Snap-On’s revenue comes from computerized diagnostic equipment and software.

This business includes Snap-On’s 2006 acquisition of the Business Solutions division of ProQuest Co., which helps car dealers electronically access information about auto parts, warranties and service bulletins. These services help over 35,000 car dealers improve their billing and inventory management systems.

In the three months ended March 29, 2008, Snap-On earned $56.6 million, up 48.9% from $38.0 million a year earlier. Earnings per share grew 51.6%, to $0.97 from $0.64. Most of the gain came from Snap-On’s overseas operations, which now provide 45% of its revenue. Rising car sales in Europe and Asia should increase long-term demand for Snap-On’s products.

However, revenue in the quarter rose just 2.3%, to $721.6 million from $705.7 million. Favorable currency exchange rates contributed $33.2 million to revenue in the latest quarter. Also, lower sales of certain tools in the United States offset strong demand for Snap-On’s industrial products.

The company needs steel and other metals to make its products, and rising costs for certain raw materials could weigh on its earnings growth. However, savings from a recent restructuring plan will help it cope with rising input costs.

Snap-On’s long-term debt of $502.7 million is a reasonable 1.8 times its annual cash flow. That gives it plenty of room to make acquisitions, or expand spending on new product development.

The company will probably earn $3.55 a share in 2008, which implies a p/e of 15.5. It also trades at 1.1 times its sales of $48 a share. The $1.20 dividend yields 2.2%.

Snap-On is a buy.

MTS SYSTEMS CORP. $32 (Nasdaq symbol MTSC; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 17.5 million; Market cap: $560.0 million; WSSF Rating: Average) makes equipment and software that carmakers and other manufacturers use to test the mechanical behavior of materials, machines and structures. This helps them reduce production errors and costs. Testing systems provide 80% of MTS’s revenue. The company also makes sensors that improve the performance of automated industrial machinery.

MTS operates in a narrow field and gets most of its revenue from customers in cyclical industries, such as automotive and aerospace. That makes it riskier than Genuine Parts and Snap-On.

MTS spends around 5% of its revenue of $24 a share on research. That helps it maintain its leading share of its niche markets. Overseas markets also supply two-thirds of its revenue, which cuts its exposure to the struggling North American auto industry.

This strong commitment to research is also helping MTS expand into new fields, such as testing systems for medical device makers. For example, manufacturers use MTS’s motion simulators to make artificial hips, knees and other implants more durable.

In its second fiscal quarter ended March 29, 2008, MTS’s earnings grew 31.1%, to $13.5 million from $10.3 million a year earlier. However, the latest quarter included tax benefits of $3.7 million. The company spent $4.5 million on share buybacks in the latest quarter. Consequently, earnings per share rose 35.7%, to $0.76 from $0.56.

Revenue grew 12.5%, to $114.5 million from $101.8 million. Favorable foreign currency rates accounted for $7 million of the revenue increase.

MTS recently sold some of its slower-growing businesses. It now has $129.4 million or $7.38 a share in cash, and just $1.2 million in long-term debt. The company will probably use some of its excess cash to buy back shares.

Earnings in fiscal 2008 should rise to $2.48 a share, and the stock trades at just 12.9 times that figure. It also trades at 1.3 times its sales per share of $24. MTS has a long history of increasing dividends. The current rate of $0.60 yields 1.9%.

MTS Systems is a buy.

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