Are We Discounting The Peak Already?

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Graham Copley / Nick Lipinski



June 11th, 2018

Are We Discounting The Peak Already?

  • As quarterly EBITDA rises as well as forward estimates, EV/EBITDA ratios are falling – suggesting that investors might be placing absolute ceilings on some sectors and many stocks within Industrials and Materials.
    • The multiple expansion has come with the market expansion and on the anticipation of higher earnings, driving ratios well above normal, more so for Materials than Industrials early this year.
    • Subsequently, Materials have given back more than Industrials but both remain well above their respective norms, though less so when compared with the overall market.
  • On a sector basis, Transports are closest to a 12 year high, but only Metals and Mining and E&C are less than one standard deviation above normal – Exhibit 1.
    • When compared to the broader market however, which is well above any of our sectors on both an absolute multiple perspective and standard deviations from normal, none of the sectors look too lofty in aggregate, except perhaps Transports.
  • At the company level, the most significantly expensive group is led by Transports – CSX, ODFL, UNP, NSC, FDX and UPS all showing up.
    • Other notables include: ROP, WABPX, EMR, EMNTRN, some of which we like more than others – we would short WAB on the GE deal – see prior research.
  • At the other end of the scale there are very few cheap stocks on an EV/EBITDA basis: the two most notable being GE and CCK, one of which we like and one of which still scares us.
    • FCX and MOS are also below 12-year EV/EBITDA ranges, though only just and we like both stories today.

Exhibit 1

Source: Capital IQ

Are We Peaking in Valuation in Industrials and Materials?

Over the last couple of years we have seen significant EBITDA growth in the I&M sectors, coupled with significant multiple expansion, and with the exception of a poor 2015, these have been great sectors since we picked up coverage in 2012 – with the benefit of hindsight we should have just said “buy everything”. As Exhibits 2 and 3 show, the ratios have increased significantly since 2012 and as shown in Exhibit 4 this has coincided with growing EBITDA. The key question today is whether the recent pullback is a bump in a continuing trend or does it mark a ceiling.

Exhibit 2

Source: Capital IQ and SSR Analysis

Exhibit 3

Source: Capital IQ and SSR Analysis

Exhibit 4

Source: Capital IQ and SSR Analysis

The interesting conclusion looking at Exhibits 2 through 4: EBITDA momentum has accelerated since 2017 at the fastest rate since 2011, but multiples in 2018 have retreated. The rate of growth has slowed in very recent months and much of the 2H 2017 trend would be anticipation of the tax act.

The absolute multiples shown in Exhibits 2 and 3 would certainly lead to caution and we would expect any sector appreciation from here to be driven by EBITDA rather than multiple – EXCEPT – Industrials and Materials are still lagging the market – Exhibits 5 and 6. The relative discount for Materials is significant, and while it always has been, the gap looks much wider today than in the past – possibly a function of trade fears and the major international exposure in general within these groups. Long Materials still looks like an interesting absolute bet, but Long Materials/Short the Market, might be an interesting relative bet.

Exhibit 5

Source: Capital IQ and SSR Analysis

Exhibit 6

Source: Capital IQ and SSR Analysis

At the company level, we show the outliers in Exhibit 7. While transports clearly benefit from the better US economy, the Tax Act (given largely US portfolios) and better industry structure, they still look very expensive – especially the rails, which could see problems if there is a real impact in trade that slowed US imports. On the flip side, not much is cheap – GE, which we have written about extensively and where we remain cautious; and CCK, where we think there may be opportunity.

While the sector work might suggest shorting a basket of Transport names and taking long Metals and Mining positions, the Transport basket is easily identified from the exhibit below, while the metals basket is not, especially with the risks associated with the trade moves – perhaps long US steel production but not steel users – and long FCX and AA.

BDC and MOS were top performers last week and UNP was one of the worst performers – not that one week means anything.

Exhibit 7

 Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Sources: Capital IQ, Bloomberg, Government Publications.

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