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Industrial Services Outlook: Near-Term Prospects Cloudy

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The Zacks Industrial Services industry primarily includes providers of industrial equipment products and MRO (maintenance, repair and operations) services. These items (repair components, cutting fluids, lubricants, safety supplies and other consumables) are utilized in production and plant maintenance but are not directly related to customer’s core products or services.
 
Let us take a look at the three major themes in the industry:
 
  • Inflation has hit the industry hard, particularly for metal-based products. The recent heightened trade tariffs left the industry dealing with higher costs of raw material and threat of undercutting business spending. Distributors continued to pass along higher prices to customers. However, it may not always be possible or adequate to cover rising product inflation in an intensely competitive environment, consequently limiting margins. However, with United States and China coming to a truce over the trade wars, this will provide a relief to the industry.
     
  • The industry’s customers are a varied lot comprising commercial, government, healthcare and manufacturing. Improved outlook and increased spending for these customers bode well for the industrial services industry given that MRO inventory accounts for as much as 40% of their annual budget. Further, the evolution of e-commerce has significantly impacted MRO demand with every passing year. In the United States, business investment and exports are two major indicators of MRO spending. Business investment is likely to grow supported by favorable financial conditions, expanding global markets, lower capital costs and an improving regulatory climate. 
     
  • Improvement in end markets like recovery in manufacturing activity, residential and non-residential construction; ongoing revival in the oil and gas industry; and economic growth will continue to drive the industry. The recent tax reform is likely to lead to higher capital spending and attract incremental foreign capital to the United States, in turn bolstering exports.
     

Zacks Industry Rank Indicates Dismal Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy prospects in the near term. The Industrial Services Industry, which is a 17-stock group within the broader Zacks Industrial Products Sector, currently carries a Zacks Industry Rank #149, which places it at the bottom 42% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
 
Our proprietary Heat Map shows that the industry’s rank has remained in the bottom half in five of the past seven weeks.
 
 
Despite the bleak near-term prospects of the industry, we will present a few industrial services stocks that can be retained in one’s portfolio given their prospects in the long haul. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
 
Industry Outperforms Sector and S&P 500
 
The Industrial Services industry has outperformed its own sector and the S&P 500 over the past year. Over this period, the industry has gained 19.5% while the S&P 500 rose 6.2%. Meanwhile, the Industrial Products sector declined 8.5%.
 
One-Year Price Performance
 
 
Industrial Services Industry’s Valuation 
 
On the basis of forward 12-month EV/EBITDA ratio, which is a commonly used multiple for valuing industrial services companies, we see that the industry is currently trading at 10.3x compared with the S&P 500’s 11.0x and the Industrial Products sector’s forward 12-month EV/EBITDA of 12.3X. This is shown in the charts below.
 
Enterprise Value/EBITDA (EV/EBITDA) Ratio (F12M)
 
 
Enterprise Value/EBITDA (EV/EBITDA) Ratio (F12M)
 
 
 
Over the last five years, the industry has traded as high as 13.1x to as low as 9.4x, recording the median of 11.2x.
 
Bottom Line
 
Improving overall economy and leading economic indicators provide general insight into projecting the industry’s growth. Further, increased investments in its e-commerce and digital capabilities, and continuous implementation of improvement initiatives within supply chain will drive the industry’s growth. Efforts to reduce cost base will also deliver returns.
 
We are presenting one stock with a Zacks Rank #1 (Strong Buy), one with a Zacks Rank #2 (Buy) and two other stocks with Zacks Rank #3 (Hold) that are witnessing positive estimate revisions that investors may consider betting on.
 
 
Harsco Corp. (HSC - Free Report) : The Zacks Consensus EPS estimate for this Camp Hill, PA-based company for fiscal 2018 has moved 2% higher over the last 90 days. The Zacks Rank #1 stock has soared 53% over the past year. The company has average positive earnings surprise history of 13.58% over the trailing four quarters.
 
Price and Consensus: HSC
 
 
HD Supply Holdings, Inc. (HDS - Free Report) : The Zacks Consensus Estimate for this Atlanta, GA-based company has witnessed a rise of 1% for the current fiscal over the past 90 days. The Zacks Rank #2 stock has gained 2% in the past year. The company has average positive earnings surprise history of 8.07% over the trailing four quarters.
 
Price and Consensus: HDS

 
W.W. Grainger, Inc. (GWW - Free Report) : This Lake Forest, IL-based company carries a Zacks Rank #3. The Zacks Consensus Estimate for the current fiscal has moved north by 2% over the past 90 days. The company has average positive earnings surprise history of 19.7% over the trailing four quarters. The stock has gained 40% over the past year.
 
Price and Consensus: GWW
 
 
TPI Composites, Inc. (TPIC - Free Report) : This Scottsdale, AZ-based company carries a Zacks Rank #3. The Zacks Consensus Estimate for the current fiscal has moved up 29% over the past 90 days. The company has average positive earnings surprise history of 249.8% over the trailing four quarters. The stock has gained 57% over the past year.
 
Price and Consensus: TPIC
 
 
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