4 Industrial Services Stocks Countering Industry Headwinds
The Zacks Industrial Services industry is bearing the brunt of contraction in order levels as customers remain cautious about spending. Supply-chain constraints and flared-up input costs have added to its woes.
Despite this current setback, the rise in e-commerce activities will be a key catalyst for the industry. Companies like W.W. Grainger, Inc. GWW, MSC Industrial MSM, Hillenbrand HI and DMC Global BOOM are poised to deliver growth, backed by their initiatives to capitalize on this demand and efforts to gain market share. The companies have also been improving their productivity and efficiency to improve margins.
About the Industry
The Zacks Industrial Services industry comprises companies that provide industrial equipment products and MRO (maintenance, repair and operations) services. It includes routine maintenance work, emergency maintenance and spare part inventory control, which keep a facility and its equipment in good operating condition. Industry participants serve various customers, ranging from commercial, government and healthcare to manufacturing. The industry's products (power tools, hand tools, cutting fluids, lubricants, personal protective equipment and consumables) are utilized in production and plant maintenance. They are not directly related to customers’ core products or services. These companies reduce MRO supply-chain costs and improve customers' plant floor productivity by offering inventory management and process and procurement solutions.
Trends Shaping the Future of the Industrial Services Industry
Contraction in Manufacturing Activity a Concern: Around 70% of the industry’s revenues are derived from sales in the manufacturing sector. Customer activity trends are historically correlated to changes in the Industrial Production Index. Per the Federal Reserve’s latest update, after declining 0.4% in May 2023 and 0.8% in June, industrial production inched up 1% in July 2023. Overall, industrial production has slipped 0.2% over the 12 months ended July 2023. The index for durable goods manufacturing was flat in May, declining 0.4% in June and up 0.8% in July. For the 12 months ended July 2023, it marked a meager improvement of 0.3%. The Institute for Supply Management’s manufacturing index was 47.6% in August, contracting for the 10th month in a row. The average for the 12 months ended August 2023 is 47.8%. Customers have been curbing their spending amid the ongoing uncertainty in the global economy and persisting inflationary trends. The New Orders Index was 47.6% in August, languishing in the contraction territory for 12 months. The manufacturing sector has also been bearing the brunt of supply-chain issues. Some of the industry players have recently noted that supply-chain issues are easing. However, the delivery of goods from suppliers to manufacturing organizations has improved lately.
Pricing Actions to Combat High Costs: The industry has been experiencing significant inflation levels, including higher labor, freight and fuel prices. The companies are witnessing labor shortages for some positions and incurring steep labor costs to meet demand. The industry players are focusing on pricing actions, cost-cutting measures, efforts to improve productivity and efficiency, and the diversification of the supplier base to mitigate some of these headwinds.
E-commerce A Key Catalyst: MRO demand is significantly impacted by the evolution of e-commerce. Customers’ demand for highly tailored solutions with real-time access to information and rapid delivery of products is rising. Customers want to execute their business activities in the most efficient way possible, which often means online. The pandemic led to a significant push in e-commerce activities. In 2022, global retail e-commerce revenues amounted to $5.7 trillion and per Statista, it is projected to be $3.64 trillion in 2023. Revenues are expected to see a CAGR of 11.2% over the 2023-2027 period and reach $5.6 trillion in 2027. In 2022, e-commerce accounted for nearly 19% of retail sales worldwide and is expected to be 25% by 2027. To capitalize on this trend, industrial services industry players are investing in e-commerce and digital capabilities.
Zacks Industry Rank Indicates Dull Prospects
The group’s Zacks Industry Rank, basically the average of the Zacks Rank of all the member stocks, indicates bright prospects in the near term. The Zacks Industrial Services Industry, an 18-stock group within the broader Zacks Industrial Products sector, currently carries a Zacks Industry Rank #150, which places it in the bottom 40% of 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries results from the negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, analysts are gradually losing confidence in this group's earnings growth potential. Over the past three months, the industry's earnings estimates for 2023 have moved down 6%.
Before we present a few Industrial services stocks that investors can add to their portfolio, it is worth looking at the industry’s stock-market performance and valuation picture.
Industry Vs. Broader Market
The Industrial Services industry has underperformed its sector and the Zacks S&P 500 composite over the past year.
Over this period, the industry has risen 6.6% compared with the sector’s growth of 13.3%. The Zacks S&P 500 composite has moved up 11.6%.
One-Year Price Performance
Industry's Current Valuation
Based on the forward 12-month EV/EBITDA ratio, a commonly used multiple for valuing Industrial Services companies, we see that the industry is currently trading at 27.31X compared with the S&P 500’s 11.32X and the Industrial Products sector’s forward 12-month EV/EBITDA of 15.02X. This is shown in the charts below.
Enterprise Value/EBITDA (EV/EBITDA) F12M Ratio
Enterprise Value/EBITDA (EV/EBITDA) F12M Ratio
Over the last five years, the industry traded as high as 33.49X and as low as 6.04X, with the median being 12.88X.
4 Industrial Services Stocks to Keep an Eye on
DMC Global: The company delivered record sales and earnings in the second quarter of 2023 aided by strong demand for its differentiated products and improved operating efficiencies at all of its businesses. Also, all three of its businesses delivered adjusted EBITDA margins of more than 20%, Actions implemented by the company earlier this year to streamline its cost structure and improve operating efficiencies have led to this improvement. BOOM’s debt-to-adjusted EBITDA leverage ratio improved to 1.3x at the end of the second quarter of 2023, representing the sixth consecutive quarter of de-levering its balance sheet. The company expects free cash flow to accelerate in the second half of 2023 and plans to end the year with a leverage ratio near 1.0x. The stock has appreciated 38% in the past year.
Broomfield, Colorado-based DMC Global provides technical products for the energy, industrial and infrastructure markets worldwide. The Zacks Consensus Estimate for fiscal 2023 earnings indicates growth of 200% from the year-ago actuals. The estimate has moved up 11% over the past 60 days. BOOM has a trailing four-quarter earnings surprise of 23.9% on average. The company currently sports a Zacks Rank #1 (Strong Buy).
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price: BOOM
Hillenbrand: High levels of backlog in the Advanced Process Solutions (“APS”) segment and efforts to drive operational efficiency will aid its bottom-line performance in fiscal 2023. The company recently closed the acquisition of the Schenck Food and Performance Materials business. This deal strengthens HI’s leadership position across attractive, growing end markets of food, durable plastics, and chemicals. This marks another step in the execution of the company’s strategy to grow as a pure-play industrial company. This acquisition is expected to be accretive to adjusted earnings per share within the first full year and deliver ROIC over the cost of capital by the fifth year. The stock has gained 17.3% in a year.
Batesville, IN-based Hillenbrand is a global industrial company operating in over 40 countries, catering to various industries worldwide. The Zacks Consensus Estimate for HI’s fiscal 2023 earnings has increased 1.5% over the past 60 days. The company stock currently carries a Zacks Rank #2 (Buy).
Price: HI
Grainger: The company continues to deliver improved results, aided by margin improvement in the High-Touch Solutions North America (N.A.) and Endless Assortment segments and a solid operating performance. GWW is well-poised to gain from efforts to increase its customer base through incremental marketing investments and effective marketing strategies. The High Touch Solutions North America (N.A.) segment will continue to benefit from pricing actions and continued volume growth. The Endless Assortment segment is gaining from customer acquisitions at its Zoro and MonotaRO businesses. Cost-control measures undertaken by GWW will sustain margins. The company also focuses on improving the end-to-end customer experience by investing in its e-commerce and digital capabilities and executing improvement initiatives within its supply chain. Its shares have gained 21% in the past year.
Lake Forest, IL-based Grainger is a broad-line, business-to-business distributor of MRO supplies and other related products and services. The Zacks Consensus Estimate for 2023 earnings has inched up 0.5% in the past 60 days. The consensus mark indicates growth of 21.5% from the prior-year reported number. GWW currently has a trailing four-quarter earnings surprise of 8.3% on average. GWW has an estimated long-term earnings growth rate of 13% and a Zacks Rank #3 (Hold).
Price: GWW
MSC Industrial: The third quarter of fiscal 2023 (ended Jun 3, 2023) marked the fifth consecutive quarter of double-digit average daily sales growth for the company. Also in the quarter, MSM delivered average daily sales growth of 11.7%, outperforming the Industrial Production index by double digits for the second consecutive quarter. MSM expects this outperformance to continue as it executes its five growth drivers, which are solidifying metalworking, leveraging its portfolio strength, expanding solutions, growing e-commerce, and diversifying customers and end markets with a particular focus on the public sector. The company’s capital allocation priority remains investing in growth initiatives to drive profitability, pursuing margin-accretive deals through strategic mergers and acquisitions, and returning cash to shareholders. The company expects additional savings of $15 million from its Mission Critical initiative. These savings, combined with solid productivity, are expected to boost margins. Its shares have risen 20% in the last year.
Melville, NY-based MSC Industrial distributes metalworking and maintenance, repair, and operations products and services in the United States, Canada, Mexico, and the U.K. The Zacks Consensus Estimate for MSM’s 2023 earnings has remained stable in the past 60 days. The consensus mark indicates year-over-year growth of 2.3%. The company has a trailing four-quarter earnings surprise of 2.3% on average. It currently carries a Zacks Rank #3.
Price: MSM
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W.W. Grainger, Inc. (GWW) : Free Stock Analysis Report
MSC Industrial Direct Company, Inc. (MSM) : Free Stock Analysis Report
DMC Global (BOOM) : Free Stock Analysis Report
Hillenbrand Inc (HI) : Free Stock Analysis Report
