Industrial stocks are typically perceived as vulnerable in a recession, as their business operations are cyclical. However, this isn't the right way to assess a company's resilience. Companies in the industrials sector that provide products or services that reduce customers' downside risks remain relevant and profitable throughout different economic cycles.
When economic conditions are poor, companies will typically terminate the services of vendors providing discretionary services such as M&A advisory, management consulting, or public relations -- but retain suppliers that address the pain points that are critical to staying in business. Companies like these operating in the industrials space include Stericycle (NASDAQ:SRCL), Ecolab (NYSE:ECL), and Middleby (NASDAQ:MIDD).
Risk of potential liabilities
Stericycle helps its customers dispose of medical waste, including items such as gloves, syringes, and needles. Its customers; such as hospitals, pharmaceuticals, and blood banks face serious repercussions like legal liabilities and regulatory penalties, if their waste isn't handled properly.
Even if the economy deteriorates, Stericycle's customers are unlikely to switch to a cheaper and unproven vendor because of the huge risks involved. In addition, the highly regulated nature of the industry and the need for a network of collection and processing facilities to serve customers efficiently deter new entrants and protect Stericycle's industry leadership -- it owns a 15% market share.
Stericycle also boasts an impressive financial track record, having increased both its revenue and earnings per share in every single year since 1998. Its unique business model and favorable contractual terms play a key role in this consistency. More than 95% of Stericycle's sales are governed by multi-year long-term contracts, which allow for price increases.
Furthermore, Stericycle has shifted its emphasis to smaller customers (over larger ones) over the past decade. In 1996, small account customers represented one-third of Stericycle's revenue, while they now make up 64% of its sales. During this period, Stericycle more than doubled its gross margin from 21% to 45%, an indication of its stronger bargaining power and the potential for upselling other ancillary services -- such as patient communication and returns management.
Risk of food poisoning and customer dissatisfaction
Ecolab provides sanitation solutions for restaurants, which ensures a minimum level of cleanliness and food safety. These solutions include staff hygiene training, bacteria resistant touch-free dispensers, no-rinse produce wash, and dish washing machine detergents.
Clean tableware doesn't just ensure food safety; it even has a positive effect on customer retention. Ecolab combined the results of a Technomic survey on restaurant consumers and another Bellwether Food study of restaurant same-store sales, and found that restaurants with higher tableware cleanliness satisfaction scores also delivered higher average same-store-sales growth. More importantly, most of the restaurants that rated highly on tableware cleanliness satisfaction use advanced machines and advanced rinse additives from Ecolab.
Ecolab's financial results speak for themselves. It has grown its revenue in every year for the past 10 years, except for 2009 where Ecolab's top line declined by only 4%. Moreover, Ecolab has remained profitable and free cash flow positive during this period.
Risk of high operating leverage
Restaurants are economically sensitive businesses bearing the brunt of high fixed costs during periods of weak consumer sentiment. Middleby helps food service operators reduce operating leverage with their cooking, warming, and preparation equipment, by cutting labor and utility costs.
For example, its TurboChef Waterless Steamer combines steaming and cooking functions in one oven without the need for water. According to Middleby, one of its seafood chain customers saved in excess of 400 million gallons of water a year with the use of its TurboChef Waterless Steamer. Other cooking equipment provided by Middleby reduce cooking time, helping to cut down on the number of waitstaff needed.
Middleby's importance to its restaurant customers is further validated by its market leadership and financial track record. Middleby is the top kitchen equipment supplier to casual dining chains, pizza chains, deli's, and steakhouses. Furthermore, it is estimated that one in three restaurants are Middleby's customers.
Similar to Ecolab, Middleby emerged relatively unscathed from the global financial crisis, with its revenue falling by less than 1% in 2009.
Foolish final thoughts
The financial track records of the three companies are the best evidence of their recession-proof characteristics, given that their top lines were relatively unaffected by the 2008-2009 global financial crisis. The key lies in the fact that Stericycle, Ecolab, and Middleby remain relevant to their respective customers because they minimize the risks that will drive customers away from businesses. Of the three, Middleby is particularly attractive, as it helps restaurants survive and even thrive by enhancing their profit margins through improved cost efficiencies.