Capitalizing on an 'industrials' renaissance

Fidelity's Brian Chang believes the capital goods industry features some companies with an attractive valuation and the opportunity to benefit from secular growth drivers.

• In recent months, a number of companies in the capital goods industry within the industrials sector have gained new appeal with Fidelity Portfolio Manager Brian Chang, who is particularly bullish on a handful of attractively valued stocks he thinks will be driven by a variety of tailwinds.
• "My optimism is largely based on durable growth in data centers and semiconductors, the reshoring of the country's manufacturing footprint, and improvement in housing," says Chang, co-manager of Fidelity Advisor^® Leveraged Company Stock Fund, along with Mark Notkin.
• The fund is a domestic equity strategy focused on companies that utilize debt on their balance sheet. Chang and Notkin favor firms with an attractive valuation and strong competitive positioning, as well as a management team that prudently uses free cash flow to grow shareholder value through mergers and acquisitions, buying back stock, and/or reducing leverage.
• Capital goods represents the fund's top industry allocation as of April 30, at about 16% of assets, roughly double the fund's exposure at the midpoint of 2023.
• Chang explains that the increase primarily reflects the strategy he and Notkin have followed to capitalize on secular growth drivers related to the reshoring of America—bringing overseas manufacturing back to the U.S.; automation; and infrastructure-related investment, including data centers and sustainable power generation, both of which have benefited from the rapid emergence of artificial intelligence.
• As examples, he cites Vertiv Holdings, nVent Electric and Trane Technologies, all of which serve data centers with solutions for power, cooling and IT infrastructure. "We believe each is well-positioned amid higher demand for data centers, driven by AI, and the specialized heating and cooling they require," Chang says.
• He adds that Eaton is well-positioned in this market with its power-management systems, so the co-managers have added to the fund's stake.
• Other outsized investments within capital goods appeal to Chang based on the uptick he expects in housing-related stocks. He notes that this is being driven by millennials, which represent the largest demographic in the history of the country, much bigger than baby boomers and Generation X.
• He explains that millennials are in their prime earning and spending years, with much of their attention and resources focused on buying a home, taking on remodeling projects to improve it, and purchasing a wide range of products to make it as functional and as comfortable as possible.
• "We view this as a major tailwind for a number of companies, particularly those that are excellent operators, have gained market share, and are pursuing value-creating mergers and acquisitions," he says.
• Specific examples within capital goods include Fortune Brands Innovations, Carlisle and WillScot Mobile Mini Holdings, according to Chang. Fortune is a play on the uptick in home improvement he expects as existing home sales pick up; the firm sells bath hardware, locks and other goods for the home. Carlisle's primary business is commercial roofing, which has grown in importance amid a focus on energy efficiency, he says. WillScot leases modular offices and portable storage units.
• Looking beyond capital goods to the consumer discretionary sector, Chang thinks a healthier housing market will benefit TopBuild, an installer and distributor of insulation and building materials, which are in increasing demand due to efforts to conserve energy. "As a large-scale provider, TopBuild sells and installs insulation—a powerful combination that allows the company to charge a premium for its products and services," Chang says.