Hit shares bullseye
Published in the Courier Mail, February 2010
Take careful aim before selecting stocks for your share portfolio, writes Karina Barrymore
Industrial stocks are like a great big smorgasbord of shares, with a huge range of companies and sectors under the one big investment umbrella.
These stocks are considered the backbone of economies, as they traditionally include manufacturers, construction and service companies that help power-up domestic growth.
In Australia, industrial stocks are just about everything except resource companies – making it easy to stay diversified. And while there are still some share market aftershocks expected from the global uncertainty, it is usually the industrials that lead us out of the downturns.
“Historically, the stocks that tend to drive an economy forward during an economic recovery are the industrial-type stocks, which are the producers of goods, or a company providing service to these companies,” Wealth Within analyst Janine Cox says.
Australian Stock Report head of research Steven Dooley also sees upside ahead.
“At the moment industrials are pretty good value, particularly some of the engineering stocks, such as Leighton Holdings and UGL,” he says.
“As the economy picks up, industrials are potentially market leaders for the next two or three years and investors should buy with that time frame in mind. Generally, they should look for stocks which weathered the downturn and for those with strong dividend yields.”
As with any cycle or trend there will be winners and losers.
STARTING OUT
A good exit strategy is a “must” when starting out.
“Almost anyone can make the decision to buy a stock and then follow through,” Cox says.
“But most people struggle to sell, therefore it is a good idea to consider how you might lock in some profit along the way.”
Wise-Owl equities analyst Tim Morris says that it’s also necessary to cherry-pick the best of the bunch.
DEBT V EARNINGS
“A strong balance sheet is the No. 1 priority and that means a company that is not carrying too much debt,” Morris says.
“Probably the first thing you should do is assess the level of debt. The simplest rule of thumb is to make sure the debt-to-earnings ratio is less than three – the debt should not be more than three times the earnings.”
For example, a company with debt of $100 million would need to have annual earnings of at least $33 million.
Morris says this debt ratio of three also implies the company it has a debt payback period of about three years, which is a reasonable period of time.
PLAY THE ADVANTAGE
“You also want a company with a strong market position, such as being a leader in its field of expertise or it is in an industry with some higher barriers to entry which would put off any newcomers,” he says.
Two Australian blue-chip industrials in this position are Brambles, which makes wooden pallets, and transport company Toll Holdings.
“Toll is a leader in the transport industry and has such big economies of scale and a dominant position that you’d be reasonably confident of their ongoing potential,” Morris says.
“In Brambles’ case, its business has very high barriers to entry. For a newcomer to make enough pallets and have a distribution network big enough to compete with Brambles would be a tough ask.”
SPOTTING POTENTIAL
Another key to choosing a good industrial stock is to look for future growth potential.
“This is something that is going to make the company’s profits increase a lot,” Morris says. “That might be a new product, new market or a strong surge in demand for its product or services.”
A couple of companies that meet this criteria are Ausenco, an engineering service company, and Clover Corporation, a food manufacturer.
These examples offer great insight about how to identify potential growth, Morris says.
Ausenco does feasibility studies for the resource industry, such as mining projects.
However, it has added to its revenue stream by adding extra services to its clients when, or if, they proceed with the project.
So, instead of just performing the assessment and collecting a fee, it also offers services right throughout the development and life cycle of the project.
As most investors understand, the resource industry is a key growth sector with a strong outlook for service firms to hitch their wagon to.
Clover Corporation extracts and manufactures omega-3 oils from fish and produces them in a form suitable for food additives in, for example, breads and dairy products.
Not only is it an emerging and growing market in Australia, but throughout the world, with demand increasing from international companies.
“Behind the company is also a broader theme toward healthier eating,” Morris says.
“Food companies also increasingly need to differentiate their products and this offers them that ability.”
NARROWING THE SEARCH
Wealth Within’s Janine Cox agrees not every sector under the big industrials umbrella will be a good bet this year, and even then it will only be certain stocks within each sector.
Sectors expected to offer good value over the medium term include finance, consumer discretionary stocks, materials and companies within the more specific industrial sector.
Within the materials sector, for example, Cox highlights Incitec Pivot.
“Food is generally a good business to be in, and it is Incitec which supplies around half the agricultural products that support Australian farmers,” she says.
“As economies around the world recover and Asia continues to forge ahead, the demand for quality food will increase – driving demand for more products from companies like Incitec Pivot.”
Another sector which benefited from the Federal Government’s stimulus spending is infrastructure. Industrial companies, such as Leighton Holdings, involved in heavy construction, such as roads, rail and mining works, or those businesses that supply these projects, such as Boral, are expected to continue to show growth in coming years.
DETOUR
But sometimes it’s what to avoid rather than what to buy that will be your best decision.
Morris says you shouldn’t look to the skies for inspiration.
“One particular pocket within the industrials market to be cautious of is airlines,” he says. “They are notoriously cyclical. They have picked up a bit lately and are looking brighter, but caution rules.”
Cox also thinks investors might like to avoid Commonwealth Property Office Fund – it’s involved in commercial property market but is heavily weighted, 60 per cent, to the lacklustre Sydney market.
Another one to be wary of, she says is Bradken, a service company to the resources and rail freight industries. Despite a recent jump in share price, it is carrying a heavy debt load.
Dooley suggests taking a detour around Crane Group, the pipes and plumbing company.
It is in a downgrade cycle, he says, after being the “market darling” a few years ago.
