Tom A's Stock Picks

Lufkin Industries - a growth story with a few sour notes

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Lufkin Industries (LUFK), a manufactuerer of oil field and power transmission equipment, has an excellent five year growth history, strong margins, and recently raised guidance for 2008 to a range of 5.10-5.30 per share. At today's price, 78.93, it trades at a P/E of 16, and is under its recent high of 85.13. The balance sheet is strong - no long term debt. This is a quality stock in an industry that is very attractive due to the long term demand for oil and the equipment to pump it. There are some issues about growth, which will become apparent from a segment review.

LUFK has been operating in three segments, Oil Field, Power Transmission, and Trailers.

Power transmission means gearing for industrial applications, more than half of it energy related. Sporting 28% growth the past two years, and 33% gross proift margins, this segment is performing very well.

Oil Field Equipment, primarily for pumping, grew 30% in 2006 and -1% in 2007. From the 2007 10-K - "Chinese manufacturers of pumping units are increasingly present in the market." First quarter 2008 results included a substantial increase in segment backlog, reflecting strong demand, sufficient to suggest that low-cost competition will not prevent the company from growing profitably. They have done some work on improving manufacturing lead time, working with customers on design, and providing service which seems to be sufficient to overcome pure price competition. Gross margins on this business are steady at around 27%.

Trailers has been a low margin business, 6 or 7% gross profit, and business conditions have become very difficult. LUFK is in the process of withdrawing from the market, generating some LIFO inventory profits on the way out. This demonstrates that management is focusing on profitable businesses where there are good growth opportunities.

Condsidering very favorable backlog information as of 1Q 2008 and the upwardly revised guidance, as well as the long term potential in oil field equipment, LUFK is a good buy at today's price. The power transmission segment is doing extremely well and is generating sufficient sales growth to compensate for the withdrawal from the trailer business.

Because the price of oil, as reflected in the furtures market, has been grabbing a lot of headlines, I do have some concerns that the price of oil related stocks, such as oil field equipment and service, may become news driven and lose connection with long-term fundamentals which I regard as favorable. Based on that line of thinking, I would plan a gradual accumulation.