Macroeconomic conditions typically affect industries in different ways. But whenever an economic decline occurs, shares of businesses operating in cyclical sectors get adversely affected.
This year’s pandemic has pushed many economies around the world close to a recession. But in November, hopes of a coronavirus vaccine drove greater positive investor sentiment. Today we will take a look at 7 cyclical stocks to buy ahead of an economic recovery in the coming weeks.
It is no secret that economic down cycles happen both in the U.S. and globally. Economic activity is generally measured by the change in the gross domestic product (GDP) over a period. Worldwide, the U.S. has been the economic leader since the second half of the 19th century. Next in line are China, Japan, Germany and India.
During downturns, economically-sensitive cyclical industries also follow the decline in the economy. As a result, share prices of cyclical companies suffer, usually losing a considerable amount of market value.
The good news is that economies eventually recover and get back on the path of growth. Then those cyclical businesses return to profitability during periods of increasing prosperity. Investors also begin to buy cyclical stocks once again.
What are some of the examples of cyclical industries? We would say auto, retail, luxury goods, travel and leisure (such as airlines, hotels and restaurants) top the list. Manufacturing and some technology firms are also affected, especially when they manufacture and sell consumer electronic goods.
Housing usually takes a hit during recessions. And finally we should add financial institutions, such as banks, in the list. As unemployment increases, disposable incomes decrease. As a result, consumers are less able to take out mortgages or borrow from banks, which affects banks’ profitability.
Consumer Confidence Matters
Business cycles are largely down to consumer confidence, which in turn affects consumer spending levels. Individuals tend to delay a number of non-essential purchases when their budgets come under pressure or when they are nervous about the financial future.
Consumer confidence is often cited by economists and even members of the Federal Reserve as a key determinant of near-term economic growth. In the U.S., the University of Michigan’s Consumer Sentiment Index and the Conference Board’s Consumer Confidence Index are among the most widely-followed measures of consumer confidence.
Trading Economics points out:
“The University of Michigan’s consumer sentiment was revised slightly higher to 81.8 in October of 2020, reaching the highest since March. Still, the sentiment remains much below 101 reported in February, before the coronavirus pandemic started.”
With that information, here are seven cyclical stocks to buy ahead of an upcoming economic recovery:
- Carvana (NYSE:CVNA)
- Culp (NYSE:CULP)
- Duluth (NASDAQ:DLTH)
- International Seaways (NYSE:INSW)
- iShares Home Construction ETF (BATS:ITB)
- LKQ (NASDAQ:LKQ)
- Vanguard Consumer Discretionary ETF (NYSEARCA:VCR)
When it comes to these cyclical stocks to buy, today’s depressed valuation discount is tomorrow’s ripping recovery rally.
Cyclical Stocks To Buy: Carvana (CVNA)
52-week range: $22.16 – $242.15
Year-to-date (YTD) price change: Up 133%
Tempe, Arizona-based used car e-commerce platform Caravana is our first stock today. A pioneer in online used car sales, this company was founded in 2012 and went public in early 2017.
The automobile industry is one of the most important sectors of our economy. Increasing disposable income levels, robust consumer confidence and the availability of easy financing, especially in a low interest environment, are typically among the main drivers of car sales.
You may notice that CVNA stock did quite well so far in the year, as it started 2020 shy of $100. In March, it plunged below $25. Since those lows, the shares are up over 800%. Put another way, a proverbial $1,000 invested in the stock in early spring would now be worth well over $9,000.
The pandemic meant most consumers shopped online, even for used cars. In late October, the company released Q3 results. Revenue of $1.544 billion meant a YoY increase of 41%. Retail units sold hit 64,414, an increase of 39% YoY.
CEO Ernie Garcia was pleased and said, “Third quarter results were incredible. We delivered another quarter of strong growth and crossed many financial milestones.”
In 2019, over 40 million units of used cars were sold in the U.S. Therefore, with a market capitalization of about $15 billion, we can expect the company to continue its growth trajectory in 2021 too.
52-week range: $5.28 – $16.92
Dividend yield: 3.12%
Year-to-date (YTD) price change: Down 1%.
High Point, North Carolina-headquartered Culp is our next choice. The company manufactures mattress fabrics and markets upholstery fabrics for furniture. Founded in 1972, the company started trading on the NYSE in 2003.
As one of the largest domestic players in the sector, CULP serves customers both domestically and abroad through its manufacturing and distribution facilities in the U.S., China and Canada.
In early September, the company released first-quarter fiscal 2021 results. Net sales of $64.5 million meant a YoY decline of 8.8%. Among the business segments, mattress fabric sales were down 7.1% and upholstery fabric sales down 11.0% YoY.
Net loss of $2.7 million meant a loss of 22 cents per diluted share. A year ago, those same metrics had been a net income of $1.8 million, or 14 cents per diluted share.
CEO Iv Culp said:
“We are pleased that both our mattress fabrics and upholstery fabrics segments saw better-than-expected increases in orders and shipments during the quarter, particularly during the last eight weeks… We believe these trends are primarily being driven by a surge in consumer focus on the home environment and overall comfort, leading to an increased proportion of discretionary spending moving to home furnishings.”
Forward P/E, P/S and P/B ratios stand at 26.46, 0.67 and 1.32, respectively. We would look to add CULP shares to holdings, especially if the price declines toward $12.5 in the coming weeks. Passive income-seekers should also find the company appealing.
52-week range: $2.82 – $17.30
Year-to-date (YTD) price change: Up 43%
Investors in Mount Horeb, Wisconsin-based Duluth stock are having a great year so far in 2020. The company sells casual wear, workwear and accessories. A number of our readers may have noticed their humorous ads.
In addition to online and catalogue sales, Duluth also has brick-and-mortar retail locations. In October, the company opened its 65th store in Florence, Kentucky.
On September 3, Duluth released Q2 results. Net sales came in at $137.4 million, an increase of 12.6% YoY. Net income and diluted EPS were $5.9 million and 18 cents. A year ago, those respective numbers had been $1.9 million, for 6 cents per diluted share.
CEO Steve Schlecht said:
“The real success story of the second quarter is the strength of the Duluth Trading brand and our e-commerce channel. Net sales grew 13% to $137 million driven by a 67% growth in direct sales year-over-year and more than doubled the first quarter’s strong direct sales growth rate.”
Forward P/E, P/S and P/B ratios stand at 10.53, 0.78 and 2.92, respectively. We’d consider investing, especially if the shares come under profit-taking in the coming weeks and fall toward $14.
International Seaways (INSW)
52-week range: $12.44 – $31.39
Dividend yield: 1.56%
Year-to-date (YTD) price change: Down 48%
New York City-based International Seaways operates oceangoing vessels. As one of the largest tanker companies worldwide, it offers transportation services for crude oil and petroleum products.
Research led by Professor Wolfgang Drobetz of the University of Hamburg, Germany recently highlighted how, “shipping is a highly leveraged, cyclical business with relatively high business risks. Given the close relationship between industry cash flows and the demand for seaborne trade, … industry risk levels exhibit a strong correlation with global economic conditions.”
The decline in INSW stock this year shows the effect of declining oil prices in 2020. As a transport company, its fortunes are largely dependent on crude oil prices and demand. Yet, with an expected decrease in health and economic pressures due to the pandemic, the shares are likely to fare better in the coming months.
Management believes things are already looking better for the group now. In early November, International Seaways released Q3 results. Net income came at $14 million, or 50 cents per diluted share. A year ago, the company had lost $11.1 million, or 38 cents per diluted share. The group’s total liquidity stood at $194 million and the net loan to value was 39%, one of the lowest among tanker companies.
CEO Lois K. Zabrocky said:
“During the third quarter, we generated solid results and increased our cash position. Moving forward, we remain positive on the long-term outlook of the tanker market. Our strategic focus continues to be on executing our disciplined and balanced approach to capital allocation, while continuing to advance initiatives that unlock significant value for shareholders.”
Forward P/E, P/S and P/B ratios stand at 8.26, 0.91 and 0.40, respectively. Long-term investors may begin to find value in INSW stock.
iShares Home Construction ETF (ITB)
52-week range: $22.39 – $60.87
Dividend yield: 0.44%
Year-to-date (YTD) price change: Up 22%
Expense ratio: 0.42%
Our next discussion centers around an exchange-traded fund (ETF), i.e., the iShares Home Construction ETF. This fund provides access to residential home manufacturers stateside. ITB which has 46 holdings, tracks the Dow Jones U.S. Select Home Construction Index. The fund started trading in 2006.
Many InvestorPlace readers will well remember how the “Great Recession” of 2008/2009 affected the home construction sector. For instance, a large number of regional builders took major hits and many did not survive. As importantly, their woes adversely impacted the general economy, including employment levels in the sector and the economic well-being of suppliers, subcontractors and financial institutions who worked with them.
The top ten home builders make up around 65% of net assets of $2.2 billion. Arlington, Texas-based D.R. Horton (NYSE:DHI), Miami, Florida-based Lennar (NYSE:LEN) and Reston, Virginia-headquartered NVR (NYSE:NVR) lead the fund in terms of individual weighting. Investors who want to add home residential home builders may want to keep the ETF on their radar screen.
52-week range: $13.31 – $38.38
Year-to-date (YTD) price change: Down 3%
Our nest stock continues on the theme of a potentially improved outlook for the auto industry. Chicago, Illinois-headquartered LKQ distributes auto products, such as replacement parts and glass products for repairing or maintaining vehicles. The group has operations in North America, Europe and Taiwan and employs over 50,000 people. The company was founded in 1998 and held its IPO in 2003.
On October 29, the company release Q3 results. Revenue of $3 billion meant a decline of 3.2% YoY. However adjusted net income of $228 million and EPS of 75 cents were up 20.9% and 23.0 YoY, respectively. Investors were also pleased to see that LKQ decreased debt by $256 million. So far in 2020, the company has paid debts of $1 billion.
CEO Dominick Zarcone said:
“We delivered exceptionally strong third quarter results… [O]ur team maintained their sharp focus on the cost structure, and we achieved the highest quarterly earnings in the Company’s history and delivered year-over-year margin improvements in each of our operating segments, with North America also achieving its highest level of segment EBITDA margin in the Company’s history.”
Forward P/E, P/S and P/B ratios stand at 13.81, 0.92 and 1.97, respectively. Any potential decline toward the $32.5 level would improve the margin of safety for long-term traders.
Vanguard Consumer Discretionary ETF (VCR)
52-week range: $118.99 – $258.30
Dividend yield: 2.49%
Year-to-date (YTD) price change: Up 28%
Expense ratio: 0.10%
Our final choice is another ETF, namely the Vanguard Consumer Discretionary ETF. The fund provides exposure to firms that manufacture, distribute or sell products and services purchased on a discretionary basis.
VCR, which has 290 holdings and started trading in 2004, tracks the MSCI US IMI Consumer Discretionary 25/50 index. The ten largest holdings make up over 54% of net assets of $4.2 billion. In terms of sector allocation, Internet & Direct Marketing Retail has the highest weighting with 27.9%, followed by Home Improvement Retail (10.9%), Restaurants (10.6%) and Automobile Manufacturers (9.5%).
Readers will note that many of the leading stocks have had a good year in 2020. Trailing P/E and P/B ratios stand at 35.7 and 5.2. In the coming weeks, there is likely to be short-term profit-taking in the top names that make up the ETF. Long-term investors may find better value in the case of a decline toward $225.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil Ph.D. has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination.