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2 Stocks to Avoid Before a Recession

The Canadian economy is not looking great in recent months. Even though oil prices have staged a remarkable jump over that period, Canada has been struggling to go from being a debt-driven economy to a more productive one. The recent GDP numbers show an economy that is heading towards contraction, not growth.

This has been a difficult transition for a number of reasons. The impact that a shrinking economy can have on wage growth and retail lending should not be underestimated. Canadian consumers are already extremely over-leveraged. Debt is essentially spending tomorrow’s dollars today.

So, what companies will likely be affected by the upcoming downturn in spending? Anything to do with home ownership may be affected. People will most likely have less money to spend on home-related items. Here are two companies you should avoid owning in the event of an economic downturn.

Leon’s Furniture (TSX:LNF)

Leon’s stores’ sales growth depends almost entirely on the strength of the domestic Canadian economy. If people don’t have any free cash, it is unlikely that they will continue to be able to spend on furniture. This is doubly true if housing prices stall or even fall since people will not be able to tap into their home equity line of credit.

Leon’s is experiencing sales growth, although it is quite slow. Total sales grew 1.2% in 2018 as compared to full year 2017. Net income was better at 7.7%, but adjusted EBITDA only exhibited 2.1% growth year over year. The report itself states that slow growth is primarily due to weakness in consumer spending. If weaker consumer spending is affecting this company when times are good, it would definitely have a negative impact if the economy took a serious turn for the worse.

Sleep Country Canada (TSX:ZZZ)

The most attractive aspect of this stock at the moment is the cool ticker symbol. The business has been around for some time and will likely be around in the future. It has been a solid business for some time now, and its products will be in demand for some time. But if there is an economic downturn, it stands to reason that people may put off buying new mattresses until the cycle begins.

With its 264 stores and 16 distribution centres covering a large part of Canada, Sleep Country is very much exposed to any disruption in economic performance. It is especially dependent on the economies of Ontario, British Columbia, and Quebec. At least two of these three provinces have elevated housing markets that could be a threat to profitability, at least in the short term, should a recession occur.

2018 full-year revenues increased 6.1% over 2017’s numbers. While this growth is decent, it has slowed by almost half when compared to 2017’s year-over-year revenue growth. This may be an anomaly, or it may represent a decrease in growth for the company. Earnings per share increased by single digits with basic earnings per share growing by 1.9% over the course of the year.

If you fear for the Canadian economy, do not own these stocks

If you have any doubt about the Canadian economy, these are two companies that you should not own. Of course, the reverse is also true. If you believe the economy is going to grow quickly, these stocks are likely to do well. These companies are domestically focused and are tied to the strength of the Canadian consumer. This means that they will most likely be negatively affected by a decline in household wealth.

These are not bad companies; they are just very exposed to the state of the Canadian consumer and the housing market. If a real downturn were to occur, these companies could be under even more pressure than they are currently experiencing. That would be a good time to buy these names, as they are good businesses that will benefit from a new upswing in economic activity. But with all the negative warning signs out there, it will be best to wait and see.

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Fool contributor Kris Knutson has no position in any of the stocks mentioned.

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