Cyclical stocks: a good way to play the broader economy.
Cyclical stocks follow the economic ups and downs. While most companies are at least somewhat affected by broader economic forces, the difference varies considerably. Sales of food, beverages and cleaning products, for example, tend to be quite insulated from recessions. By contrast, when the economy tanks, cyclical stocks fare the worst. If it has too much debt, a cyclical company may even fall into bankruptcy during a downturn. This possibility came to the forefront in 2020 during the COVID-19-induced economic stoppage. Industries such as travel and transportation, hospitality and energy saw their revenues plummet. This year, however, the economy quickly recovered, boosting cyclical stocks’ fortunes. It’s not too late to buy into the area, though. A new variant of the COVID-19 virus, omicron, led to sharp selling around Thanksgiving, particularly in a few key cyclical sectors.
Exxon Mobil Corp. (ticker: XOM)
The Thanksgiving sell-off centered on the energy sector. The price of crude oil plunged more than 10% in a single day, marking one of the worst one-day performances for the commodity in its history. The price of oil had been up sharply in 2021, based around economic reopening and the inability of producers to get new supplies into the market. However, the threat of more travel restrictions and stay-at-home orders crashed the party for oil. With it, major players like Exxon Mobil gave back a sizable chunk of their gains. However, it seems people may have overreacted to bad news during a low-volume holiday week where there weren’t many traders around to buy the dip. Oil has already bounced following the Black Friday plunge and that should stabilize the energy sector. Meanwhile, Exxon trades for under 11 times forward earnings and is paying a 5.9% dividend yield.
Valero Energy Corp. (VLO)
Like Exxon Mobil, Valero is strongly tied to the health of the overall economy. In some ways, Valero is even more of a cyclical operator. Whereas an integrated oil major like Exxon earns money from a variety of sources, a refiner like Valero profits largely from the demand for end products such as gasoline, heating oil, jet fuel and asphalt. A refiner processes huge quantities of oil and hopes to earn a small margin on every barrel that goes through the pipes. During demand shocks, however, that margin can turn negative, leaving refiners in trouble. On the flip side, if supply abruptly falls, for example during a hurricane in the Gulf Coast, refiners make windfall profits. Right now, traders are worried that the omicron variant will cause a big dip in the consumption of gas and jet fuel. If vaccines and other containment measures can handle omicron, however, that fear would be misguided. In the meantime, Valero shares trade at just 11 times forward earnings and offer a 5.9% dividend yield.
Southwest Airlines Co. (LUV)
On the flip side of energy, there are the airlines. At first glance, airline stocks might seem like winners with a crashing price of oil — after all, jet fuel is one of their major cost centers. However, the threat of more travel lockdowns has more than overshadowed that benefit. Airlines such as Southwest are trading back down near 52-week lows. Furthermore, with the recent decline, Southwest’s shares are now trading at a 20% discount to their pre-pandemic levels. The company, however, made it through COVID-19 without too much lasting damage. Thanks to its high-quality balance sheet, it didn’t have to heavily dilute shareholders or take on too much debt during the downturn. And given its strong financial position, it was able to seize opportunities as markets reopened. Analysts see Southwest returning to profitability in 2022 and nearing normal levels of earnings in 2023. The analyst consensus is for more than $4 per share of earnings in 2023, which would put the stock at less than 11 times earnings.
Polaris Industries Inc. (PII)
Polaris is a classic cyclical company. The company manufactures fun consumer products such as snowmobiles and all-terrain vehicles. Not surprisingly, demand is heavily influenced by underlying economic conditions. In theory, Polaris should be having an amazing 2021. After all, people have been spending at record levels this year and Polaris makes the sorts of toys for grown-ups that are in high demand lately. Polaris has indeed taken advantage of the moment; it has reported record revenues and profits in recent quarters. However, the supply chain shortage has smacked the powersports industry, leaving manufacturers struggling to keep the assembly lines rolling. In the grand scheme of things, that’s not the worst problem to have. Polaris is generating plenty of consumer interest. And now with the stock off 20% from its highs, it sells for just 12 times earnings.
PulteGroup Inc. (PHM)
If investors learned anything from 2008, it’s that housing prices don’t always go up. Rather, when the housing cycle turns negative, it can devastate the entire economy. However, people may remember that lesson a little too well. Many pundits seem eager to look for the next “big short” in the housing market. But conditions have changed dramatically and regulators have tightened up lending policies. The U.S. housing market has far fewer low-quality loans than in 2008, and the banks are much better capitalized. The system got a stress test in 2020 and passed with flying colors. Yet, once again, folks are selling homebuilders like PulteGroup out of fears that the next big housing crash is at hand. However, household incomes are soaring and the millennial generation finally seems ready to buy their own houses, giving the market a demographic boost. That’s great news for PulteGroup, which sells for less than six times 2022’s estimated earnings. Homebuilders could enjoy another leg higher as current worries fade.
Otis Worldwide Corp. (OTIS)
Elevator-maker Otis had been climbing to new highs for most of the year. Industrial conglomerate Raytheon Technologies Corp. (RTX) spun off shares of Otis in early 2020. This was poor timing, given that the pandemic killed demand for the deal. Since the spin-off, however, OTIS shares have now advanced from $45 to about $83, thanks to rising demand. That’s not surprising; given the housing boom, developers are building more multi-family apartments. That’s good news for an elevator company. There is also an attractive long-term business model here, as Otis gets to enjoy subscription-like revenue streams from servicing its elevators in the years and decades after installation. Otis shares peaked at $93 this summer but have pulled back about 10% on concerns of a slowing market and less demand from some international geographies. For traders wanting cyclical exposure, however, that could be a good buying opportunity as the recent spin-off resumes its upward climb.
Restaurant Brands International Inc. (QSR
Restaurants have been one of the most heavily impacted industries due to the pandemic. First, they shut down entirely or only had delivery operations for an extended period. Restaurants have largely reopened for normal service now, but some customers remain reluctant to dine out in public. Meanwhile, the labor shortages and escalating supply chain issues are causing major cost pressures for restaurants. Restaurant Brands is among those feeling the heat. The company is primarily known for its Burger King, Popeyes and Tim Hortons brands. Shares are down about 20% from their 52-week highs given the above mix of problems. Over the longer term, however, large chain restaurants should be able to gain market share amid the shake-out in the broader industry. As the global supply chain starts to normalize and the labor market finds a new post-pandemic equilibrium, large dining firms like Restaurant Brands should be able to mount a comeback.
Seven cyclical stocks to buy now:
— Exxon Mobil Corp. (XOM)
— Valero Energy Corp. (VLO)
— Southwest Airlines Co. (LUV)
— Polaris Industries Inc. (PII)
— PulteGroup Inc. (PHM)
— Otis Worldwide Corp. (OTIS)
— Restaurant Brands International Inc. (QSR)
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