Investing in Industrials

This sector groups companies dedicated to the manufacture and distribution of capital goods, the provision of commercial and professional services, and the management of transport infrastructure and services. Unlike the old approach focused only on production, the current MSCI classification is oriented towards market demand, grouping industries that deliver value through infrastructure and global operational support.

MSCI

The Industrials sector (or Industrials), according to the MSCI GICS structure, is assigned code 20.

The sector is divided into three main industry groups, with their respective subsectors detailed below:

1. Capital Goods (Code 2010)

This group covers the manufacture of heavy machinery and equipment for various industrial purposes.

• Aerospace and Defence (20101010): Manufacturers of civil or military equipment, aircraft parts, defence electronics and spacecraft.

  • Example: Lockheed Martin, Northrop Grumman, Raytheon, Boeing, General Dynamics, BAE Systems, Airbus, Safran, Thales, etc.

• Building Products (20102010): Manufacturers of components for buildings and home improvement products (excluding timber or cement).

  • Example: Carrier, Trane, Johnson Controls, Masco, Fortune Brands, Stanley Black & Decker, etc.

• Construction and Engineering (20103010): Companies focused on non-residential construction and large-scale civil contractors.

  • Example: Fluor, Jacobs, AECOM, KBR, Vinci, Bouygues, etc.

• Electrical Equipment (201040): Manufacturers of electrical cables, motors, generators, heavy turbines, solar power systems and industrial batteries.

  • Example: ABB, Siemens, Schneider Electric, Eaton, Honeywell, First Solar, etc.

• Industrial Conglomerates (20105010): Highly diversified companies operating in three or more GICS sectors, where no single activity dominates. General Electric is the typical example used by MSCI for this sub-industry.

  • Example: GE, 3M, Honeywell, Roper Technologies, etc.

• Machinery (201060): Includes manufacturers of heavy trucks, agricultural and forestry machinery (tractors, seeders) and industrial machinery (elevators, pumps, 3D printers).

  • Example: Caterpillar, Deere, CNH Industrial, PACCAR, Volvo, Otis, Kone, Xylem, Stratasys, etc.

• Trading Companies and Distributors (20107010): Wholesale distributors of industrial equipment.

  • Example: W.W. Grainger, Ferguson, Fastenal, WESCO, etc.

2. Commercial and Professional Services (Code 2020)

Includes companies that provide operational support to other businesses and governments.

• Commercial Services and Supplies (202010): Covers commercial printing, environmental services (waste management), office services and supplies, and security and alarm services.

  • Example: Waste Management, Republic Services, Cintas, Aramark, Securitas, Clean Harbors, etc.

• Professional Services (202020): Includes employment and HR agencies, consulting and research services, and data processing or outsourcing companies.

  • Example: Robert Half, ManpowerGroup, Adecco, Gartner, Booz Allen, Leidos, Paychex, etc.

3. Transportation (Code 2030)

This group comprises freight logistics and passenger transport.

• Air Freight and Logistics (20301010): Courier services, air freight and customs agents.

  • Example: FedEx, UPS, DHL (Deutsche Post), Expeditors, C.H. Robinson, XPO Logistics, etc.

• Passenger Airlines (20302010): Companies that mainly provide air transport for people.

  • Example: Delta, United, American Airlines, Southwest, Lufthansa, IAG, Air France-KLM, etc.

• Marine Transportation (20303010): Transport of goods or people by sea (excluding cruise lines, which are in Consumer Discretionary).

  • Example: Maersk, Hapag-Lloyd, COSCO, Frontline, Matson, etc.

• Ground Transportation (203040): Includes freight and passenger railways, ground freight transport, and road passenger transport services, including on-demand transport platforms (such as ride-sharing services).

  • Example: Union Pacific, CSX, Norfolk Southern, BNSF, J.B. Hunt, Uber, Lyft, etc.

• Transportation Infrastructure (203050): Operators of airports, roads, tunnels, rails and seaports.

  • Example: Ferrovial, Aena, Vinci (airports), Transurban, Atlantia, etc.

Characteristics

Cyclicality and the economic cycle

Industrial earnings and sales are usually highly correlated with the economic cycle. This is one of the sectors where macroeconomics matters most; even so, some subsectors weather recessions better.

It is advisable to tilt investment towards the end of recession or early expansion, to gain a margin of safety. To assess business cyclicality in a simple way:

• Who is the end customer and how are they affected by a crisis?
• Is demand for the product inelastic?
• Number of competitors: highly competitive sectors tend to be more cyclical; those dominated by few players tend to have lower cyclicality (better control of supply).

Economies of scale and supply chain

Many industries benefit from economies of scale (unit costs that fall as production increases thanks to specialisation, technology or bargaining power with suppliers and distributors). At the same time they depend on a supplier and distributor network; supply chain disruptions (as in the COVID-19 crisis) can significantly affect production and profitability.

Order backlog

Industrial companies often work with order backlogs. It is advisable to analyse:

• Order volume: that it is maintained or growing.
• Time horizon of the backlog (years of confirmed orders).
• Historical trend and outlook for the backlog (often more informative than current sales).
• Contract terms (lead times, prices, clauses).

In cyclical companies it is essential to analyse ROIC over the full cycle, not just the latest figure, to avoid value traps when the cycle is at a peak.

Competitive advantage (MOAT)

It is important to understand what makes the company’s product special and why the customer chooses its products over the competition, reducing substitution risk. It is advisable to identify the moat within the subsector and its pillars:

• Advantage through scale?
• Patents or intellectual property?
• Switching cost (cost of changing supplier)?
• Low-cost producer position?
• Brand or pricing power?
• Operation in an oligopoly or duopoly?

Key metrics

Capital and margins

Highly capital-intensive sector: CAPEX is high and recurring. To normalise CAPEX you can use the average CAPEX/sales ratio of main competitors or of the subsector (do not mix subsectors).

Indicative operating margins:

Common valuation multiples

• EV/EBITDA: 9–13x
• EV/EBIT: 10–14x
• P/E: 10–20x
• EV/FCF: 10–20x

The range is wide due to the diversity of subsectors. Multiples will depend on business cyclicality and backlog, margins, EPS and FCF growth, moat, ROIC and debt level (above 2x net debt/EBITDA usually penalises).

TOP company example

• TransDigm Group Inc.