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Portfolio Update

Swapping Industrial Stocks

By Elliott H. Gue, on Jul. 3, 2014

In particular, we expect the refining and chemicals end-markets to enjoy a multiyear growth story. Both industries benefit from rising US production of oil, natural gas and natural gas liquids (NGL) from the Bakken Shale, Eagle Ford Shale and other unconventional plays.

US ethane prices are the lowest in the world, thanks to rising production of this NGL. Ethane is a key input in the production of ethylene, a commodity chemical that serves as the building block of many plastics and synthetic materials. Petrochemical firms with significant production capacity on the Gulf Coast have enjoyed record profit margins because of cheap US feedstock.

A significant expansion of petrochemical capacity is already under way on the Gulf Coast, but the trend will accelerate starting in late 2015 and early 2016. As a result, Jacobs won’t unlikely to enter the sweet spot of its growth cycle until next year; in the near term, its backlog of projects has been flat.

Although the market overreacted to the company’s most recent earnings results, the company did encounter real challenges in the first quarter. In particular, Jacob’s acquisition of Australia-based Sinclair Knight Merz (SKM) wasn’t as accretive as hoped. Management also noted weakness in the minerals and mining markets in Australia and indicated that those issues may linger over the next few quarters.

Bottom Line: Jacobs Engineering Group is a solid play on the expansion of US petrochemical capacity, but this growth story won’t pick up until 2015 or 2016. In the near term, the SKM acquisition could take longer to realize its full potential than originally expected. For these reasons, stock could be dead money for the time being.

Although we’ll hold income stocks through temporary wobbles to continue collecting dividends, capital gains account for much of the total return in growth-oriented stocks. To outperform, investors should rotate out of laggards and deploy the proceeds into names with more near-term upside.

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