It's not shaping up to be a vintage year for the industrial sector, but that doesn't mean investors can't find stocks to buy at attractive prices. There's no doubt that railroad Union Pacific (UNP -0.13%), diversified manufacturer Dover Corporation (DOV -1.35%), and industrial software company Dassault Systemes (DASTY -0.66%) are facing significant earnings headwinds in 2020, but there are strong arguments for them being a good value for long-term investors.
Union Pacific
The railroads are the veins and arteries of the U.S. industrial sector. If the U.S. economy is in good shape, then so are the railroads, and vice versa. That's the bad news and the good news about Union Pacific in 2020. It's bad because the railroad is certain to take a major hit from the COVID-19 pandemic and the measures taken to contain it. It's also good, because it means the railroads will surely benefit when the economy turns up.
Image source: Getty Images.
The latest rail traffic data from the Association of American Railroads shows total carloads are down 8.2% for the year to date, compared to the same period last year. Moreover, they are down 23.8% in the week ending on April 11.
Clearly, Union Pacific is heading for a horrific second quarter, but long-term investors need to consider a few things:
- The fact that railroad traffic is so integral to the economy means that when activity picks up you can have a high degree of confidence that the railroads will start to see it in their revenue too.
- The Class 1 railroads act as effective duopolies in their geographies, so Union Pacific is highly likely to emerge from the downturn with its market position in tact.
- All the listed Class 1 railroads have to opportunity to generate underlying improvements in their profitability thanks to adoption of Precision Scheduled Railroading management techniques.
Furthermore, the dip in Union Pacific's share price now means the stock comes with a useful 2.6% dividend yield. As you can see below, the payout ratio (dividend divided by earnings) is still relatively low, and free cash flow is easily covering dividends too. This suggests Union Pacific's dividend is safe, and given that the 10-year treasury yield is just 0.6%, Union Pacific is a good option for income-seeking investors.
Data by YCharts
Dover Corp
The engineered products company and Dividend Aristocrat will certainly take a hit from the COVID-19 pandemic, but it has an opportunity to bounce back from it in due course. There are two main reasons why. First, as the chart below shows, Dover is exposed to a wide range of end markets, and many of them are in areas that are likely do well in a recovery.
For example, retail fueling and the automotive aftermarket are likely to do well when cars get back on the road, especially as gasoline prices have fallen significantly. In addition, food retail and waste management are not often seen as defensive sectors to invest in. Those areas will help offset weakness in industrial applications, hospitality, restaurants, and oil and gas. The latter is an area Dover has significantly reduced its exposure to in recent years.
Data source: Dover presentations. Chart by author.
The second reason comes from management's self-help initiatives intended to reduce selling, general, and administrative (SG&A) costs in order to improve operating margin. In addition, the plan calls for reinvestment to encourage growth and improve profitability.
The chart below shows the progress the company has made in the last couple of years. Management plans to generate more improvements in 2020.
Data by YCharts
Dassault Systemes
Engineering software company Dessault Systemes is also highly likely to see its sales impacted by the COVID-19 pandemic. After all, companies tend to cut back on investments in developing new products when their own sales growth is in reverse gear. No matter, Dassault has a number of long-term trends behind it that should enable strong growth to resume after the COVID-19 pandemic is contained.
In a nutshell, the growth of the Internet of Things (IoT) and digitization of the factory is creating significant growth opportunities for companies like Dassault. It's not always appreciated, but industrial companies are set to be the big winners from the IoT revolution.
Before web-enabled technologies were in place, companies would use industrial software like Dassault's computer-aided design or simulation software, in order to better engineer solutions. However, with the advent of the IoT, these solutions can now be fully integrated into a product lifecycle management (PLM) approach.
PLM is the cycle in which a product, say an airplane or mining infrastructure, is conceived, designed, and ultimately manufactured. Thanks to the use of the IoT, and Dassaut's software platforms, this process can be made more efficient. It also allows different departments of the company to collaborate on the engineering and development of new products.
Before COVID-19 spread around the world, industrial software sales were growing strongly on an industry wide basis, and that trend is likely to continue when the economy recovers.
