I often have the feeling we forget about industrials. There is nothing sexy about them. There is often minimal stimuli to create hype on the stock market. Even worse, this sector is not seen as a source for high dividend yields. As many industries operate through unique economic cycles, there are always a few industrials for sale.
Many industrial companies are 50+ years old. This is probably one of the few sectors where you can list many companies that have survived through a whole century. Due to their long-standing existence, they have built solid core businesses and commensurate impressive brand recognition. Those who have survived the passage of time and found ways to evolve often make solid dividend payers.
Sub-Sectors (Industries)
Greatest Strengths
Barriers to entry are legion in most of the industries in this sector. It’s quite difficult to secure military contracts or to build railways for a new, inexperienced business. Most industrials are large companies involved in massive spending in R&D and operate enormous facilities around the world. Since many industrials are old companies, you can often pick a business that has survived the last three recessions and kept its dividend alive as well. This is a great proof of time and relief when you can go through a challenging period on the market.
Many industries will also enjoy repetitive contracts or sales. While the overall demand will fluctuate to follow the economy, those enterprises can often count on a solid core demand coming from their customers. In many cases, they operate sticky business models. Industrials will develop extensive expertise in niche domains and will offer customized solutions to their customers. It makes the switching costs significant when your entire business is tied to services or products that have been co-developed with your suppliers.
Greatest Weaknesses
The most significant problem with industrials is probably the fact that they often become too large to be managed effectively. We are all aware of the multiple problems at General Electric (GE) which has had to cut its dividend twice between 2008 and 2018. In other words, the longevity of a company is not necessarily an accurate predictor of its likelihood of paying or increasing its dividend.
The other characteristic to track for industrials is their size as a business and their debt levels. Companies that have existed for long periods of time tend to grow through different segments and divisions. At one point, you look at the company and it becomes difficult to fully understand where their true expertise resides. This is what happened with GE.
Industrials will be required to invest massively in R&D and the construction of their facilities. When demand slows down, the company is often left with unused machinery and resources. Those are costly moments.
How to Get The Best of It
Trends! Industrials are likely to follow cycles. Railroads, construction equipment companies, truck manufacturing, and trucking transportation will be quite busy during economic booms but will suffer during recessions. If you follow a specific industry closely, you will be able to catch great businesses when their stock price is devalued by the market.
There are several fragmented markets where a leader will make acquisitions to increase its market share. You can either target smaller players with low debt or go for the major player who wants to consolidate its position.
The industrial sector is best for growth investors, but you can often find some solid candidates for income investors.
Favorite Picks
Lockheed Martin (LMT)
- Market cap: 95B
- Yield: 3.05%
Business Model
Lockheed Martin is the largest defense contractor globally and has dominated the Western market for high-end fighter aircraft since being awarded the F-35 program in 2001. Lockheed’s largest segment is Aeronautics, which is dominated by the massive F-35 program. Lockheed’s remaining segments are rotary & mission systems, which is mainly the Sikorsky helicopter business; missiles and fire control, which creates missiles and missile defense systems; and space systems, which produces satellites and receives equity income from the United Launch Alliance joint venture.
Investment Thesis
LMT now benefits from more generous international sales regulations. As geopolitical tensions continuously rise around the globe, Lockheed Martin is in a great position to offer its products to other countries. LMT counts on its F-35 fighter aircraft program and missile defense systems to grow in the upcoming years. The company enjoys a strong bond with the U.S. government and provides high-quality defense products. There are very few competitors in these markets and LMT is increasing its order backlog at a rapid pace. LMT is currently paying down its debt and showing stronger cash from operations. What’s not to like?
TFI International (TFII.TO) (TFII)
- Market cap: 8B
- Yield: 1.30%
Business Model
TFI International Inc is a transportation and logistics company domiciled in Canada. The company organizes itself into four segments: package and courier, less-than-truckload, truckload, and logistics. The package and courier segment picks up, transports, and delivers items all across North America. The less-than-truckload segment transports smaller loads. The truckload segment transports goods by flatbed trucks, containers, or via more specialized services. The company provides general logistics services through the logistics segment. TFI International derives most of its revenue from Canada with the United States being the next most significant source of revenue.
Investment Thesis
As TFI is expanding, it may be time to jump in their truck and ride them for a while. Expanding outside Canada has been its smartest move since both the U.S. and Mexican economies have great potential. With a larger fleet, TFI will be there to pick up any available steady growth in the future. Investing in a leader in Canada and North America overall is a safe bet for anyone building a dividend growth portfolio. The company displays an appetite for further growth by acquisition in the years to come. Their most recent move (UPS Freight) will add over $3B in revenue. The stock price soared on that news.
For TFI the lines in the revenue chart and the normalized diluted EPS chart seem to end partway thru 2020 instead of into 2021 as the other 2 do. Why is that?
Hello Frank,
That’s a good question, I’d have to check with Ycharts. It’s probably related to the timing in reporting their financial information.
Cheers,
MIke