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Stock Watch

6 Stocks to Cash In on the Capital Spending Boom

These companies will prosper as corporate America starts to upgrade and replace plants and equipment.

Ever since the start of the economic recovery, forecasters have been waiting for corporate America to go on a spending spree for everything from heavy machinery to expensive software. After all, making capital investments is key to expanding and main­taining a competitive edge. Yet instead of updating aging buildings, machinery, software and other big-ticket items over the past few years, many, if not most, U.S. companies have used their burgeoning cash hoards to buy other companies—or shares of their own stock. That has left factories, airplanes and communications equipment in a historically geriatric state and has arguably weakened worker productivity.

See Also: 7 Best Dividend Stocks of the Dow

But now the tide appears to be turning. Year-over-year growth in capital spending in the U.S. picked up markedly in the second quarter. By the end of the first half of 2014, annualized capital spending hit an all-time high of $2.2 trillion. “We’ve had a big increase in heavy-equipment purchases—earthmovers, forklifts and all sorts of oil-drilling machinery—not to mention software and anything that relates to the cloud,” says Carla Freberg, of Balboa Capital, which makes corp­orate loans secured by big-ticket items.

Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., expects corporate spending on big-ticket items to continue to grow faster than the overall economy over the next year and possibly for years to come. That should boost sales and profits for well-situated companies. Here are six that look particularly attractive.

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Many analysts are high on Honeywell International (symbol HON) because of its broad scope and ability to thrive even during tough times. Over the past five years, Honeywell delivered steady gains in revenue and profits while other industrial concerns stagnated. Things are looking even better now that capital spending is picking up. For starters, Honeywell is benefiting as airlines scramble to replace aging jets; the average age of planes in U.S. fleets is a record 10.3 years. The company’s aerospace unit makes engines and navigation systems, as well as wheels, brakes, and communications and safety equipment.

Another Honeywell segment helps industry and individuals better manage energy use. This division is likely to profit from an upswing in commercial construction, says Ivan Feinseth, an analyst with Tigress Financial Partners, a New York City investment firm. Meanwhile, the growth in fracking and domestic oil and gas production is giving a boost to Honeywell’s petro­chemical division. Analysts at Stifel, Nicolaus & Co. see the stock reaching $112 in a year, 20% above its current price of $92 (all prices are as of October 3).

United Technologies (UTX) and Eaton Corp. (ETN) are likely to benefit from many of the same trends. Both firms operate in the aircraft industry, with United’s Pratt & Whitney division making aircraft engines and Eaton involved in hydraulics and fueling systems. Both companies are also key players in commercial construction. United produces Otis elevators and escalators and makes fire-detection and alarm systems. Eaton’s Cooper Industries unit produces thousands of industrial and electrical products.

Shares of United Technologies slid over the summer, partly due to investor disappointment with the company’s second-quarter results. Still, Brian Langenberg, an independent analyst in Chicago, sees the stock, now $104, reaching $125 within the next 12 months.

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Eaton stock also tumbled last summer, but analysts say the company’s history and dominant market position make the shares attractive. Even if another aerospace company comes up with better products, Eaton’s flight instrumentation and hydraulic systems are so ingrained in many military and commercial aircraft designs that it would require costly re-engineering for the com­pany’s customers to switch suppliers, says Morningstar. The company’s electrical products are also leading-edge. If the construction and aerospace industries expand as expected, Eaton is likely to deliver better growth than most big industrial concerns.

General Electric (GE) is becoming less eclectic as it returns to its industrial roots. In 2013, it sold its 49% interest in NBC Universal to Comcast, and in September it agreed to sell its home-appliance business to Electrolux for $3.3 billion.

GE’s stock has languished since 2007, partly because about one-third of the company’s revenues and profits come from a financing arm that was slammed in the global credit crisis. But S&P Capital IQ analyst Jim Corridore thinks the ongoing restructuring will sharpen GE’s focus on its industrial segments, where demand is picking up. GE derives 17% of its annual sales of some $146 billion from power equipment, such as turbines and generators, and it gets another 15% from aircraft engines and parts.

GE’s sales are likely to be flat this year and next, but Corridore is more optimistic about profits, which he expects will rise 14% in 2014 and 10% in 2015. He expects the stock, now $25, to reach $32 within a year. The stock yields a hefty 3.5%, so even if it gets only halfway to Corridore’s bullish target, it could deliver a total return approaching 15%.

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Tech surge. Companies that sell computers, software and data storage will also get a lift as businesses upgrade their technology. Because technology advances rapidly, it’s rare for businesses to skimp on IT purchases. But that’s just what they did last year, leading to the first year-over-year drop in data-center spending since 2009, says Brent Bracelin, an analyst at Pacific Crest Securities, in Portland, Ore. Data centers allow firms to track everything from employees and inventory to customer records. The infrastructure is much like a home’s plumbing: You only notice it when it doesn’t work.

NetApp (NTAP), which provides hardware and software that let customers store their data more efficiently, should benefit from the rebound in corporate technology spending, Bracelin says. The 22-year-old company is unlikely to grow as rapidly as some of the newer players in cloud computing. In fact, NetApp’s revenues fell slightly in the fiscal year that ended on April 25. But between share buybacks and spending cuts, earnings per share rose a whopping 34%. The same trend continued in the quarter that ended on July 25. But with tech spending picking up, analyst Mark Kelleher, of D.A. Davidson, expects NetApp’s sales to start rising again and earnings to climb faster than revenues. At $42, NetApp shares trade for 13 times estimated earnings over the next 12 months. Bracelin thinks the shares will reach $46 over the coming year.

Whether it’s aircraft parts or building supplies, every product that’s purchased must somehow be shipped from the manufacturer to the end user. That’s where Trinity Industries (TRN) comes in. The maker of rail cars, tankers and inland barges is perfectly positioned to capitalize on growing spending by railroads and industrial companies. “It’s the biggest rail car manufacturer with the most capacity,” says UBS analyst Eric Crawford. “If you are a company that needs a couple thousand rail cars to handle upcoming demand, your first phone call is going to Trinity.”

Trinity has benefited enormously from the domestic energy boom fueled by fracking. That’s because rail cars are needed to deliver the sand and chemicals used in the extraction process, as well as transport the oil, gas and propane that fracking produces.

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The impact on Trinity’s results has been stunning. Over the past four years, revenues have more than doubled and profits have soared fivefold. With much of the company operating near full capacity, growth of that magnitude can’t continue, and analysts expect earnings to be flat in 2015. That explains why the stock, at $41, trades for just 11 times estimated year-ahead profits.

But Crawford thinks most analysts are too pessimistic. Among other things, Trinity plans to open a new manufacturing facility in Georgia to handle growing demand for rail cars. His one-year target for the stock is $60.