Which industry sectors are best placed to withstand the recession? Three factors should help you sort the wheat from the chaff: cyclicality, current financial strength and growth potential. Tim Bennett explains.
Which industry sectors are best placed to withstand the recession? Accountancy group PricewaterhouseCoopers (PWC) has taken a look at how vulnerable 15 major British business sectors are to the downturn. The group's head of macroeconomics, John Hawksworth, looked at three main features: cyclicality, current financial strength and growth potential. So which sectors should stay strong and which should you avoid?
1. Cyclicality
Analysts often describe sectors as either cyclical or defensive (counter-cyclical). Defensive sectors are those that have proved their ability to weather a previous downturn, whereas cyclicals tend to get dragged rapidly into the mire. But what is 'cyclicality'?
PWC splits it into two aspects. First there's what they call the 'economic beta'. This is the relative responsiveness of the output of a sector to overall changes in national gross domestic product (or wealth) over the last 20 years. In other words, this measures how tightly a sector is tied to the overall economic cycle. The higher the beta of a sector, the more sensitive it is to a sudden change in GDP and the greater its vulnerability to recession. So, for example, the post and telecoms sector has an economic beta of 2.3, meaning that for every 1% decrease in GDP, this sector sees, on average, a 2.3% drop in output. That sensitivity increases its final 'vulnerability score'.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Next, there's the 'equity beta'. This focuses on how sensitive the shares within a particular sector are to overall stockmarket movements. A high beta on this measure (anything above one, says PWC) points to greater volatility and a bigger risk that the sector will be disproportionately pummelled as the economy tanks. On this measure, for example, utilities scored 0.8, which suggests as you might expect that they are "less susceptible to the general economic cycle".
2. Current financial strength
Hawksworth then reviewed key ratios for over 600 listed British firms, aiming to find which "can generate significant cash from either retained profits or external resources". These have an edge, as not only are they well placed to ride out a recession, but they may also "be able to improve their market positions through organic growth and picking up assets at bargain prices".
The first of the four indicators used was decent profitability measured as return on capital employed (ROCE) financial services firms came bottom on this measure. Next, the ability to service existing debt and even raise more was tested using gearing (the ratio of debt to equity funding from the balance sheet) and interest cover (profit before interest as a multiple of one year's interest expense). Chemicals firms scored well here. Lastly, a high 'quick' ratio (current assets as a multiple of current liabilities) helps to show whether a firm has decent short-term liquidity.
3. Growth potential
Here, PWC took three separate measures of long-term growth potential, starting with each sector's average long-term output growth trend over the past 20 years. Overall, British GDP has grown at around 0.65% per quarter over that period, so a number above that is a good start. For the business services sector, for example, it's over 1%, whereas for oil and gas it's 0.3%, due in part to dwindling North Sea output. Secondly, the p/e ratio was measured on the basis that, after the recent battering taken by share prices, anything rated above-average must be viewed by analysts as a decent bet. Lastly, the study reviewed the ratio of exports to total domestic output. The aim was to expose export-intensive sectors. A high score is bad news, says PWC, as in a downturn, "exports tend to be more volatile than domestic demand".
Winners and losers
Metal products emerges as the worst sector. It is the most vulnerable to the downturn, says the report, due to a combination of high cyclicality and volatility (equity beta 1.6), limited potential for future growth and the lowest level of interest cover of any sector, despite modest gearing levels. Financial services comes a close second, followed by hotels and restaurants. So you should also steer clear of any firm that employs either star bankers or celebrity chefs.
However, PWC likes chemicals, a sector dominated in Britain by big pharma firms. In the short term, they can rely on a "steady flow of orders from the NHS". We like GlaxoSmithKline (LSE:GSK), on a yield of 5.4%. Next come food retailers such as Tesco (LSE:TSCO) yield 3.7% and utility firms such as National Grid (LSE:NG), which yields 5.8%. As the report concludes, "electricity, gas and water suppliers are more affected by regulatory regimes and weather conditions than short-term economic fluctuations", making them a relatively safe shelter as the storm rages.
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.
He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.
‘Inheritance tax insurance’ enquiries are soaring – but is it worth it?
MPs warn over Lifetime ISAs which could leave savers out of pocket
