The surprising strength in domestic manufacturing sales reported this week is a welcome development for all Canadians. For investors, the obvious question is how to translate the acceleration in manufacturing activity into portfolio returns. The industrials sector is the obvious place to look for opportunities.
Released Wednesday, the Statistics Canada data on Canadian manufacturing were unequivocally positive, as noted by National Bank Financial senior economist Krishen Rangasamy in an e-mail to clients.
"In Canada, manufacturing shipments rose 1.7 per cent in July, after an upwardly revised 1.5 per cent increase the prior month. That was well above the 1.1 per cent increase expected by consensus," Mr. Rangasamy wrote. "Sales rose in 12 of the 21 broad industries, including a 6.3-per-cent jump for the transportation sector thanks to gains for both autos and aerospace … Real orders were up a massive 5.9 per cent."
Canada's manufacturing renaissance is in its early stages and year-over-year growth in activity remains in negative territory. If sustainable, however, the trend could result in significant returns for investors who get in early.
To find the stocks likely to benefit most from the trend, I measured the sensitivity (in terms of stock price) of all companies in the S&P/TSX industrials index against nationwide monthly manufacturing sales data.
There were five stocks that stood out: Russel Metals Inc., Toromont Industries Ltd., Westshore Terminals, Canadian National Railway Co. and Progressive Waste Solutions Ltd.
The top chart shows the close association between domestic manufacturing activity and the stock price of Russel Metals over the past decade. As a provider of the basic inputs for manufacturers – from aluminum and steel to fencing and pipe – the company is well positioned to benefit from growth in the industry.
Russel Metals should be considered a speculative investment and readers should study fundamental research in detail before considering adding the stock to their portfolio. The slowdown in year-over-year profit growth for the company suggests the indicated dividend yield of 6.8 per cent may not be sustainable if earnings growth continues to slow. The average analyst target price implies a small simple return of 5 per cent for the 12 months ending December.
The Bank of Canada's interest rate policy is designed to weaken the loonie and spur exports, so it's no surprise that Canadian National Railway will benefit from an increase in manufacturing for export purposes. Automotive transportation is not a dominant part of CN's business, but the strength in the domestic auto sector could wind up as a significant source of revenue growth for the railway. The average analyst target price suggests a 10.3-per-cent return for the year ending December without the 1.7-per-cent dividend.
I included the major domestic auto parts providers – Magna International Inc. and Linamar Corp. – in the analysis even though they are classified as consumer discretionary stocks, not industrials. Surprisingly, despite the increase in Canadian auto production, the two stock prices showed very little correlation to the manufacturing growth trend.
Follow Scott Barlow on Twitter @SBarlow_ROB.