Worst five industries for 2009 (1)

I’m a believer in analyzing broad industry groupings as a means of getting into good investments and getting out of bad ones. Of course, there will always be companies that defy the movements and performance of their peer groups. Some companies are tough to pigeonhole in one industry due to diversified lines of business; others are simply excellent companies that are resistant to industry-wide shifts and movements. But by and large, figuring out broad industry projections is a first, critical step for me in deciding where to put my money.

For 2009, there are not a lot of winning industries out there. Far easier is identifying those industries to avoid. These might be no-brainer, easy calls, but here is the first of five industry groupings that will underperform the market this coming year.


Retailing

A poor second half of 2008, a poor Christmas season, and a positively dismal outlook for 2009. Avoid retailers at all costs! One way of gauging just how bad it’s been for the retailing industry is to look at the bankrupt portfolio companies of private equity firms. Three of the six 2008 PE bankruptcies (Linens ‘N Things, Mervyn’s, and Steve and Barry’s) featured yesterday in an article on the Wall Street Journal website are retailers. There will be more to come, both publicly traded and privately owned.

Retailers are facing a brutal convergence of factors. For the first time in a generation, Americans are saving again, which means less consumption, and even when retailers are able to move product, short-term deflation will limit revenues for the first half of 2009. Because most retailers sink or swim based on volume, retailers tend to cluster together – in shopping malls, downtown shopping districts, and the like – and the death of one retailer tends to hurt the business of those remaining. The classic nightmare scenario for a shopping mall is the loss of a major tenant, especially a so-called “anchor” tenant like Macy’s (NYSE: M), which then cuts into mall traffic and sales volume, forcing smaller retailers to shutter operations, which then allows remaining businesses to renegotiate lease contracts or to move outright. It can become a vicious cycle and plays perfectly into my industry-based view of the markets.

As an aside, you might want avoid retail landlords, like General Growth Properties (NYSE:GGP) and Tanger Factory Outlet Centers Inc. (NYSE:SKT), as well. These companies have direct and unavoidable risks associated with retailers for the reasons touched on above, and many will go bust in this cycle. A few, like Simon Property Group (NYSE:SPG), are more diversified in their holdings and operations, but will still feel pain emanating from the retail industry.


The Survivors

Having said all of this, not all retailers are the same. In this environment, low cost trumps high quality (and given the evolution of retailing in the US, cost usually trumps quality even in good cycles); therefore, the established, preferred providers of low-cost goods should do okay. That means Wal-Mart (NYSE:WMT) will be a winner in the down cycle. Target (NYSE:TGT) is another that should see modest earnings growth. Especially well-run specialty retailers in healthy niches will also survive in good shape. For instance, I’ve been surprised at the strength of Lowe’s (NYSE:LOW) in 2008, which is down only 6% and has maintained its small dividend. Even Home Depot (NYSE:HD), Lowe’s sickly competitor, has weathered 2008 in decent shape, having lost only 16% off its market cap (but bear in mind, it is down a staggering 65% since 2000, so much of its value had already withered away). The home-improvement niche overall is only down 10% in 2008. As more and more people defer large expenditures – and as existing home owners struggle to maintain the value of their homes – this might be an area of retailing that holds its share value. Pure-play pharmacies are another retailing area that will outperform the rest of the retailing industry, but at the end of the day, there are probably better places to put new investments. If you already have shares in these “survivors,” a Hold recommendation is probably the order of the day, but accumulating more stock in these companies should be delayed, certainly until the second half of 2009, when inflation and an improving macroeconomic landscape might reverse the retailing sector’s decline.