Given the current macroeconomic climate of not only the U.S. but now the rest of the world, it is not surprising that most industrial stocks are seeing a substantial slowdown in their businesses. Recently, short-sellers have positioned themselves negatively against Caterpillar (CAT), Bucyrus (BUCY), Joy Global (JOYG) and Terex (TEX)—betting that these industrial names still have more room to the downside

One compelling name that might have further to go on the downside is Woodward Governor (WGOV), which designs, manufactures and services energy control systems and components for aircraft and industrial engines and turbines. Woodward Governor shares are not cheap at all, trading with a forward P/E of 10.9, PEG ratio of 1.1 and enterprise value/EBITDA of 6.4.

For the fiscal year ending September 2008, Woodward Governor’s net sales were up 20.7%, from $1 billion dollars in 2007 to $1.3 billion in 2008, yet Woodward Governor had net earnings of only $121 million dollars in 2008, which equates to just10.3% operating profit for the company.

World demand for fuel-efficient, low-emissions and high-performance energy systems drives the products-and-services section of Woodward's business. Its customers use Woodward's systems and components for controlling engines, turbines and other equipment for power generation and distribution. Unfortunately, this is a highly cyclical business, which can easily be cut by clients during times of weak sales.

Woodward's Energy Control and Optimization Solutions is a nice feature to offer fluid management customers when oil is $145 a barrel, not when it's at $35. It's simply not economically sensible to assume or even renew current contracts.

Furthermore, Woodward's integrated systems technologies focus on fuel systems, combustion systems, fluid systems, actuation systems and electronic systems, all of which are highly dependant on high oil prices to drive their businesses.

Woodward's turbine systems segment, which combines the aircraft engine systems business segment with the industrial gas turbine and process industries, focuses on systems and components that provide energy control for industrial and domestic aircrafts. Given the troubles at Boeing (BA) and that company's recent firing of 2,500 workers, investors should have no part of any company that supplies airline producers.

Woodward is also involved in the weakening wind business, making various components for wind turbines. On Jan. 5, DMI Industries, a unit of Otter Tail (OTTR), cut 20% of its workforce, stating that "difficult credit conditions continue to impact the ability of wind energy developers to secure needed project financing."

This thesis is supported by a piece in BusinessWeek called “A Chill Blows Through Wind Power." According to Emerging Energy Research, the piece says, "new installed wind capacity worldwide will increase by just 14% in 2009 -- less than half the typical annual growth rate booked in the past decade."

Additionally, the higher cost of capital, tighter credit and overall lack of demand has taken the legs off past turbine demand.

Other companies involved in the wind space are Broadwind Energy (BWEN), which is sitting on its 52-week low, and Quanta Services (PWR). Owens-Illinois (OI) makes the special windmill blades, which do not break under extreme stress.

Given Woodward Governor's dependence on the price of oil, global demand for aircrafts, the creation of new wind turbines and the company's still-high valuations, investors should avoid shares of Woodward Governor for some time.

It is also worth noting that about a month ago, there was heavy put-buying activity in Woodward's deep-out-of-the-money April $12.50 puts, bringing volume over nine times the normal amount. This sort of speculative action is an outright bet that Woodward stock has more room to fall.

Posted on Jan. 20, 2009