Does this company’s trading update mean that there isn’t a recession coming imminently?

Question mark made up of pound symbols

I wrote an article earlier in the week about Europe-facing building materials supplier SIG, which asked the question, Does this company’s trading update mean there’s a recession coming?”

The firm had just updated the stock market about challenging market conditions and lower revenues for the trading year just gone. I said I don’t want to be holding the shares of any cyclical business if a recession is on the way, so it felt safer for me to avoid SIG’s shares.

Good trading

Today, we have an update from a company trading in the same sector, called Grafton Group (LSE: GFTU), and the commentary reads rather differently. The firm distributes building materials to trade customers in the UK, Ireland, the Netherlands and Belgium. It’s also the “market leader” in the DIY retailing market in Ireland and, on top of that, it’s the “largest manufacturer” of dry mortar in the UK, which means the firm has a few more strings to its bow than SIG, although operations are all highly cyclical in nature, and around 85% of overall operating profit comes from merchanting with just 9% from manufacturing and 6% from retailing.

You might have heard of some of the firm’s trading brands in the UK, such as Selco, Buildbase, Plumbase, Leyland SDM, MacBlairand CPI EuroMix. The Grafton set-up overall includes some 675 branches across all trading areas, so it’s a sizeable enterprise and therefore, another useful barometer to help us gauge conditions at the ‘coal face’ of the European economy, even though around 70% of revenue derives from the UK.

The update covers trading for the year to 31 December and constant currency revenue grew 8.4% compared to the prior year. Meanwhile, average daily like-for-like revenue increased by 4.3%. The directors said in the report that “the rate of growth moderated in November and December following above trend growth in September and October.”  But that’s as close as Grafton gets in its update to the rather negative impression about trading conditions I got from SIG. Indeed, Grafton expects earnings before interest tax and amortisation (EBITDA) for 2018 to be “ahead of the top end of analyst expectations,” which sounds bullish.

A positive outlook

Chief executive Gavin Slark said in the update that Grafton’s “cash generative businesses, strong balance sheet and low level of net debt support our development strategy for the year ahead.” The wording in the update betrays no sign of any doubts in the outlook, and City analysts following the firm expect a mid-single-digit percentage increase in earnings next year.

The share price is perky today, but despite the well-covered dividend yield and the positive outlook, I’m still reluctant to take on the single-company risk that comes with a cyclical operator like this in what looks like a mature stage of the current cyclical upswing in the economy. There may not be an imminent recession coming, but just as with SIG, I’m avoiding shares in Grafton and would rather spread my risk by investing in an index tracker fund, which would provide diversification because of the large number of enterprises making up the index the tracker follows.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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