Industrials: Stocks Remain Fully Valued, but Opportunities Exist Across the Sector

The Morningstar US Industrials Index has slightly outperformed the US Market Index in the second quarter. Industrials continue to benefit from the rotation away from software to hard assets and stocks within the sector with exposure to the AI buildout continue to perform well. Industrials had given away some gains due to geopolitical concerns, but the sector rallied in recent months along with the market.

While we view the sector as being fully valued, there are compelling investment opportunities across most industry groups, particularly in farm machinery, aerospace and defense, and construction industries.

We expect fundamentals in the aerospace and defense industry to hold up relatively well, as healthy demand dynamics persist across both the commercial aerospace and defense markets. Aerospace will receive a boost from the doubling of the aircraft fleet over the next two decades, and the defense industry should be a beneficiary of increased defense spending amid a highly volatile geopolitical environment.

While some sectors, like autos, remain highly exposed to tariffs, the Industrial sector’s profitability remains robust despite tariff-related uncertainty. Continued geopolitical turmoil can potentially have an impact on the sector given its impact on energy and raw material prices, supply chain disruptions, and production constraints. Geopolitical and supply chain concerns have eased, and we have not seen material disruptions yet. Inflation remains persistently higher than the Federal Reserve targets, and rates remaining higher for longer looks increasingly likely. High interest rates are a major headwind for industries like construction, building materials, and home building.

Sticky inflation and an uncertain economic outlook may force the central banks to tighten monetary policy, keeping interest rates high. Recent geopolitical events and inflation worries have reignited downside risks for the housing industry as mortgage rates have risen to about 6.5%. AI buildout and other related themes are powering economic growth in the US, but the growth in industrial production remains sluggish. Capacity utilization remains on a downward trend after the post-pandemic boom.

Top Industrial Sector Picks

Vontier VNT

• Fair Value Estimate: $48.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

Vontier is an industrial technology company offering transportation and mobility solutions. While growth in convenience retail (roughly two-thirds of the firm’s revenue) has been solid, organic growth has been dragged down by weaker results in repair solutions. The latter has faced headwinds due to a challenging macroeconomic environment, which has weighed on repair technician sentiment and pressured discretionary spending, particularly on high-ticket items. Nonetheless, we view these headwinds as transitory and expect repair solutions to return to more normalized organic revenue growth in the low single digits once the macroeconomic pressures are alleviated.

CarMax KMX

• Fair Value Estimate: $96.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

CarMax is the leading used vehicle retailer, with over 255 stores, all in the United States. CarMax has not resisted the shift to online retailing, but we think it has not done a good job of messaging its robust omnichannel capabilities to consumers. Once it revamps its website and improves messaging, we expect rising sales. Former IHG CEO Keith Barr became CEO in March, and the stock may have an overhang until he gives a deep dive on his four-pillar strategy in late fall. The pillars focus on offering a broad selection with an easier online experience that complements the in-store experience, all while reducing overhead and reconditioning costs. Once Barr settles in, we expect share buybacks to resume.

Lennar LEN

• Fair Value Estimate: $124.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: High

Lennar is the second-largest homebuilder in the US. The company has become more asset-light, with 98% of its lots controlled via options. The stock has corrected about 50% from its 2024 highs as the rate outlook changed and the market became skeptical of Lennar’s long-term margin profile following its transition to a land-light strategy. Lennar’s margins may underperform in the near term, but its operating model and enhanced scale should enable it to close the gap with peers in the long run. The market is pricing the stock as if homebuilding margins will not improve from the current levels, which we think is excessively pessimistic.