The industrials sector is one of the main industries to watch as we approach the peak in the economic cycle. Due to the nature of many industrial businesses, the revenue and operations are susceptible to a decrease in spending from other companies, as they reduce capital spending to manage their own businesses.
Some of the main businesses that will be most affected by a reduction in spending across the economy are businesses that supply other companies with goods or services.
When the economy starts having problems, all bets are off, so it’s best to avoid these industries ahead of time and find some companies in more defensive industries.
Two main industrial stocks that should be avoided today are Magellan Aerospace (TSX: MAL) and Finning International (TSX: FTT).
Finning International
Finning International is a retailer and the largest Caterpillar dealer of equipment and other products to businesses around the world.
It operates in Canada, South America, the U.K., and Ireland, with more than half of its revenue coming from Canada.
It makes money through sales of new equipment, used equipment, rentals and product support, with product support and new equipment sales making up the bulk of its revenue at more than 90% of sales.
It sells its equipment mainly to the construction, mining, and power systems industries, all three of which make up roughly 90% of its business.
These industries are highly exposed to the current economic conditions, so any issues with the economy could prompt companies to scale back their capital spending, which would consequently impact Finning’s business greatly.
Just looking at the most recent recession in 2008 and 2009; the stock was sold off more than 60% from its high in 2008 to its low in 2009.
Although the stock was sold off heavily last year and hasn’t come close to recovering, it still trades at a 16 times price-to-earnings ratio, so if its earnings were to be impacted, we could see its stock get sold off even further.
Magellan Aerospace
Magellan designs, develops, manufactures, and repairs a vast number of components to the aerospace industry.
Although this is a great industry to supply and be exposed to in expansionary times, Magellan could be at risk of counterparty cost cutting when the economy inevitably ends up in a recession.
Looking back to the last recession again, the stock was decimated, far worse than Finning. It started getting sold off in 2007, but even taking just its high from 2008 and comparing it to the low of 2009, the stock was sold off nearly 95% — a massive hit to the stock and its investors.
What’s even worse, from its bottom in 2009 it took roughly five years to get back to its 2008 levels, meaning investors who held the whole time really could have found a much better place to store their funds.
What it does have going for it is that this time around, more of its clients are government entities, which won’t be as affected by a recession. In fact, some governments even choose to increase spending during recessions to give the economy a boost through fiscal policy.
Nonetheless, it’s still exposed to a reduction in spending, so investors who are holding the stock may want to liquidate their position or at least trim some of it to mitigate potential risk.
Bottom line
Knowing which industries will be most affected in a recession and steering clear of them is a crucial step when managing your portfolio ahead of a recession.
If you do have any of these stocks in industries to avoid, you will want to sell them as soon as possible or risk taking a major hit to your portfolio if a bear market comes sooner than you expected.
