Business Week: Why Cooper Industries Could Tool Up

Since early 2001, the pace at Houston-based Cooper Industries has been ho-hum. Like the rest of industrial America, this maker of electric components and equipment has been stuck in a manufacturing recession. And on top of the slowdown, it's dealing with the potential cost of covering payouts on asbestos claims related to a former subsidiary.

Yet all signs are pointing to a manufacturing rebound and an economic recovery in 2002. Investors in companies such as Cooper, which has been implementing cost savings through the downturn, could be rewarded later this year as growth picks up. And Cooper's stock may be cheap now. Even with the recent rise in its share price, from $31 to $36, the stock has a lot more room to run, says Morningstar analyst Josh Peters.

At an affordable price-to-earnings ratio of 12 times 2002 earnings, Peters estimates fair value on Cooper stock at $53, a 32% jump from its current price. Standard & Poor's [like BusinessWeek Online, a unit of The McGraw-Hill Companies] includes Coopers as one of its 35 ``Power Picks'' for 2002.

OPEN TO OFFERS. The most recent price run-up can be tied to Cooper's efforts to calm a nagging worry in recent days. Although the company announced weak financial results on Jan. 24, Cooper also informed investors that it would take an after-tax charge of $30 million as an added reserve for possible asbestos liability. Management went a step further, promising ``no diminution of future earnings [will be] arising from this matter.''

Nailing down its asbestos risks could also clear the way for Cooper to be acquired, which could push the stock price sharply higher. Now that the company has a dollar figure on its possible asbestos exposure beyond its insurance coverage, analysts suspect that Washington [D.C.]-based Danaher or another diversified conglomerate could renew its interest in this lean and mean manufacturer.

In August, Danaher made an unsolicited stock and cash bid for Cooper. Back then, Cooper rejected the offer, which was worth $54 to $58 per share, or somewhere around $6.5 billion to $7 billion, including assumed debt. But Cooper's management has made clear that it's open to selling the company as a whole or piecemeal.

``ON THE CUSP.'' The linchpin of Cooper's success in 2002 could be the economic recovery itself. In recent weeks, a number of signs began hinting that the decline in spending on new facilities and factory upgrades is starting to bottom. The manufacturing industry's key gauge of factory production, the Institute for Supply Management index [formerly called the National Association of Purchasing Management index] is expected to near the critical 50% level for January.

The index has been below 50% since August, 2000, suggesting that the manufacturing economy has been in recession since then. A reading above 50% would indicate that the economy is on the road to recovery. ``We see the ISM index coming in at 50 on the dot,'' says Sam Stovall, senior investment strategist at S&P. ``Right now, we're on the cusp of growth vs. contraction, though the trend itself points to growth.''

Improved investor sentiment for cyclical companies that should benefit from a recovery could be a strong elixir for manufacturing stocks. ``The more [Wall Street] thinks a recovery is coming, the more some of these diversified industrials will benefit in terms of stock price,'' says Eric Jemetz, an analyst at New Amsterdam Partners. ``Fundamentals are not part of this argument at all.''

TRIMMING SUPPLIES. Morningstar's Peters points out that Cooper is no longer an unwieldy conglomerate. It's focused on two businesses -- electric products and tools and hardware -- in which it holds leadership positions. The company ``really shrank itself and has been taking out a lot of structural costs,'' he says. ``I expect it to be significantly more profitable when things pick up.''

Cooper has been reducing inventories diligently. At the end of the fourth quarter, they stood at $671 million, down from $707 million in the same period a year ago. Cash flow has been strong, reflecting the more focused, slimmer business, Peters says. ``We saw a steep drop in business conditions, but the company held onto cash pretty well.''

Cooper does still face some asbestos-liability risks, though not like those dogging companies such as Dow Chemical [through its merger with Union Carbide] or Georgia-Pacific , which have more direct exposure. Cooper's vulnerability is more complicated -- and most likely less costly.

RECOUPED PAYOUTS? In 1998, auto-parts maker Federal-Mogul bought a Cooper subsidiary called Abex. As part of the deal, Federal-Mogul agreed to cover liabilities related to Abex' products. But Federal-Mogul's asbestos exposure from other businesses drove it into bankruptcy last fall. Now, Federal Mogul may not honor its end of the deal with Cooper.

If that happens, the payouts could end up back at Cooper's doorstep. However, should Cooper have to pay any Abex-related asbestos claims on Federal-Mogul's behalf, Cooper would become a creditor in Federal-Mogul's bankruptcy proceedings, which means it should get repaid for most of its expenses at some point.

That's not to say Cooper is totally out of the woods. Some on Wall Street remain nervous. ``As we've seen with the long list of those who have asbestos-litigation exposure and have since filed for bankruptcy, it's difficult to quantify accurately,'' says Nicole Parent, an analyst with Banc of America Securities. Cooper declined comment for this story.

NEAR-TERM DRIVER. Asbestos litigation has been relentless since the 1970s, when the insulation material was found to cause serious health problems, including cancer. Brand-name companies, including energy-services company Halliburton and diversified-chemicals maker Dow Chemical, are still wrangling with asbestos claims. In recent years, these expenses have sent chemicals maker W.R. Grace and building-materials companies Owens Corning and USG into bankruptcy.

Still, economics rather than legal concerns are most likely the main near-term drivers of Cooper's stock performance. And a disappointing 2002 for Cooper isn't out of the question. It's coming off a horrible 2001. Fourth-quarter results were hurt by weakness across all its markets -- telecom, electronics, residential, automotive, industrial, and utilities. Earnings were down all through 2001.

Eli Lustgarten, an analyst with H.C. Wainwright, says he's hoping Cooper turns in flat earnings for the year, compared to 2001, when it had sales of $4.21 billion and earnings per share of $2.69. Cooper expects $3.00 in EPS this year, including approximately $0.50 per share due to new accounting rules.

If the economy gains momentum, though, Cooper could beat those expectations. And there's nothing like merger speculation to help run up a target company's stock price. Sure, limited asbestos exposure adds some risk to Cooper stock. But so far that's not turning out to be the Achilles' heel that investors feared at first. And if a decent recovery develops in 2002, Cooper's stock could have a strong wind at its back.