Monthly Review February 2014 – No January Effect as Industrials Fade With the Market

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Graham Copley / Nick Lipinski



February 2nd, 2014

Monthly Review February 2014No January Effect as Industrials Fade With the Market

  • Metals remain unloved a month into 2014 – with the notable exception of Alcoa. Despite AA’s 12% relative gain on the month, the group as a whole was the worst underperformer of a lagging Industrials and Basics space. Paper, and Packaging stocks were best insulated to the selloff, and Conglomerates performed considerably better without the weight of GE.
  • Thus far, earnings season has seen its share of hits and misses, but on the whole revenue growth has been positive for every Industrials and Basic Materials sector, save Paper and Packaging, which, interestingly, were the two best performing sectors in January.
  • The Metals sector is nearly two and half standard deviations below normal value on our framework, the largest valuation discount the group has seen since 1980. Transports are looking increasingly less expensive than they have been, as KSU was severely penalized after earnings and UPS missed the revenue mark it had previously guided down to.
  • In January we updated our work on Optimism and offered 2014 picks for the Chemicals sector, the mid-cap space, and large cap Industrials and Basics. We also published blogs on CAT and Activism in the Chemicals space (see our recent client conference call for our comprehensive take on this topic).
  • Our preferences at the sector and stock level are shown in Exhibit 1 below. AA appears to have some real momentum behind it– we noted in 2013 that the stock has tended to move quickly when it moves. It remains attractively valued despite this recent gain. Another longtime favorite, CAT, spiked on positive earnings and we see further upside for the stock.

Exhibit 1

Source: SSR Analysis

Exhibit 2

Source: SSR Analysis – Normal Value looks at valuation relative to historical norms and the SSRSI measures current valuation versus current return on capital and what movement in returns on capital is implied in valuation.

Exhibit 3

Source: Company Reports and SSR Analysis

Appendix 3
for the data underlying this exhibit.

Exhibit 4


Earnings season thus far has been accompanied by downward revisions, most severe in the Metals sector. FCX, NEM, NUE, and STLD have all lost 10% or more from their 2014 EPS estimates since the start of the year. Yet performance within the Metals group was very disparate in January – five of the worst 14 performers were Metals stocks, but AA posted the second largest gain in our universe (+8.3%) and beleaguered miner NEM was one of the biggest winners before giving it back and more following its earnings release on the last day of the month. Paper, meanwhile was aided considerably by the large late month upward revisions to UFS’ 2014 and 2015 EBITDA – the stock was up 11.5% on the 31st alone to surpass Alcoa as the best performer on the month.

UPS announced in mid-January that its Q4 results would be lighter than anticipated due to Christmas delays, then in its earnings announcement at month’s end gave a 2014 EPS outlook that trailed consensus estimates.

Rail company KSU was the other primary culprit in the Transports sector’s negative revisions and underperformance, dropping its 2014 estimate by 38 cents and losing 16.5% as the seventh worst performer in our coverage. Best and worst performers at the company level in our coverage universe are summarized in
Appendix 1

Exhibit 5 summarizes 2013 year over year revenue growth by sector and subsector. Parentheses indicate the number of companies that have reported. Note that for Capital Goods the sum of companies reporting by subsector does not equal the sector total, as some stocks are included in multiple subsectors.

Exhibit 5

Source: Capital IQ and SSR Analysis

Sector performance relative to the S&P is shown in Exhibit 6.

Exhibit 6

Source: Capital IQ and SSR Analysis

Exhibit 7 summarizes end-January sector discounts from normal value. The valuation discount in the Metals sector is the highest seen since 1980. Transports lower valuation premium is the result of underperformance on the month and the incorporation of new fiscal year capital data into several of our company models. As the Exhibit suggests, GE is indeed the cheapest Conglomerate; however, while without GE the sector is the third most expensive, this premium is driven by the lofty valuation for HON (3.21 standard deviations above normal). MMM and DHR remain slightly undervalued.

Exhibit 7

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are shown by sector in Exhibit 8. As a reminder, our Skepticism Index measures how in or out of phase current valuation is with current returns on capital. A positive number suggests that either valuation is discounting a decline in return on capital or the stock has upside. On the flip side, a negative number suggests that returns have to rise to justify valuation, or the stock has downside.

The Chemicals sector saw the biggest move in skepticism index value over January, gaining 0.15 points to approach 1 – the group as a whole is over-earning, more so than even slightly expensive valuations would suggest. Note that the return on capital metric captures forward 12 month earnings estimates and part of the reason why the Paper sector screens here as it does is because consensus estimates for 2014 call for huge earnings gains over 2013. Also note that not all earnings release driven revisions will have worked their way into consensus for companies reporting late in the month so we would expect further significant moves in this chart at the end of February.

Exhibit 8

Valuations Underestimating Current Returns on Capital

Valuations Overestimating Current Returns on Capital

Source: Capital IQ and SSR Analysis

Exhibit 9 is a very busy chart but shows how each sector and sub-sector breaks down by SSRSI component – valuation versus ROC. All things being equal, you want to buy sectors in the top right corner and sell those in the bottom left.

Exhibit 9

Source: Capital IQ and SSR Analysis

Portfolio Performance

We again tracked our model portfolios over the month, one based on our normal mid-cycle earnings screen, one based on our Skepticism Index and one based on the stocks that appeared on both metrics. Effectively, we bought the cheapest/most Skeptical and we sold short the most expensive/least Skeptical, as summarized in Exhibit 2 of our January monthly.

In 2013 our portfolios showed strong performance, particularly the overlap screen of companies appearing on both the Valuation and Skepticism Index screens – aggregating the monthly returns for the year, the overlap portfolio gained nearly 16% (excluding transaction costs) – Exhibit 10.

Results or our January 2014 screens are summarized in Exhibit 11, showing performance relative to the S&P, which dropped 3.5% month over month – we did not fare well in January.

Exhibit 10

Source: Capital IQ and SSR Analysis

Exhibit 11

Source: Capital IQ and SSR Analysis

Appendix 2
we show the companies coming into our screens and leaving our screens.

Macro Environment

At SSR we are not economists, nor do we seek to be. We look at the economic indicators that are publicly available and put them into context relative to the drivers within the industries we cover. We examine trends or fundamental influences and we then look at these relative to valuation with the goal of identifying mismatches between what is implied in valuation and what is expected to happen.

Emerging economies are showing some early signs of distress in the post-taper environment. The ripple effects of the Fed’s gradual tightening have been felt in the currencies of Turkey, Indonesia, and South Africa, and their central banks have rushed to raise interest rates accordingly. Chinese manufacturing activity contracted for the first time in six months as the country’s breakneck growth continues to wane.

A slew of economic data indicated that the US ended 2013 on somewhat shaky footing, though the effects of unusually cold weather are indeterminate –
see recent research by our colleague Rob Campagnino
. Durable goods orders for December came in markedly below expectations and the prior month’s strong figure was revised down. The December jobs report was disappointing as well, and new home sales plunged. The initial 4th quarter GDP figure came in right in line with expectations, as continually strong consumer spending made up for the lost output from the government shutdown in October. The removal of such federal drags is one reason for optimism in 2014, though business investment will likely need to pick up to ensure a continued recovery.

The most recent Macro data changes are summarized in Exhibit 12.

Exhibit 12

Source: Capital IQ, Government Publications, Bloomberg, SSR Analysis

Commodity Pricing

Natural gas pricing continued to surge in January, as a bitter cold spell has hit much of the country; prices jumped past $5.00/mmBTU for the first time in four years. Crude prices, meanwhile, moderated, closing the gas-oil gap.

Metal pricing was universally down amid emerging market currency chaos. Copper production is expected to outstrip demand in 2014 after lagging in 2013, and prices continue to moderate from 2012 highs; copper was down 6%, steel lost 2%, and aluminum was off 5%.

US commodity prices and energy prices are indexed in Exhibits 13 through 17.

Exhibit 13 Exhibit 14

Source: Capital IQ, IHS, CRU Steel Price Index, Bloomberg, SSR Analysis

Exhibit 15

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 16 Exhibit 17

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

Expectation Analysis

In Exhibit 18 we look at expected net income growth by sector, comparing 2015 estimates with 2012 actual net income. This exhibit will be updated with 2013 net income figures as full year data comes in. Paper, Transports and Packaging maintain their impressive growth estimates, while Capital Goods remains the only sector expecting a decline in net income from 2012 levels. Net income for the Metals space is anticipated to be essentially flat, while Electrical Equipment shows little net income growth despite a significant valuation premium.

Exhibit 18 Exhibit 19

Source: Capital IQ and SSR Analysis

Exhibit 20 shows how these longer term estimates have changed over the month. Paper and Metals were both down significantly on the month, on both weighted and unweighted measures. Estimate adjustments here were pervasively negative – unweighted, only Capital Goods, Electrical Equipment, and Conglomerates (ex. GE) showed even a small increase.

Exhibit 20

Source: Capital IQ and SSR Analysis

Exhibit 21 summarizes changes in 2014 EPS estimates over the past month. Revisions were most negative for the Metals sector, resoundingly so. Cuts were widespread, and the group as a whole would have been down nearly 7% even without large cap FCX’s big cut to 2014 EPS. Conglomerates estimates were little changed on an unweighted basis but cap effects enabled UTX and HON to make up for a small drop for GE. Electrical Equipment and Paper were the only other sectors to see material positive revisions. Paper’s gain was due mostly to UFS, which saw a large increase in EBITDA estimates for 2014 and 2015. Performance is being reasonably driven by revisions – Exhibit 22.

Note that the numbers in Exhibit 21 differ from those in Exhibit 4 as the data is market cap weighted in Exhibit 21 and is a simple average in Exhibit 4.

Exhibit 21 Exhibit 22

Source: Capital IQ and SSR Analysis Source: Capital IQ and SSR Analysis

Mid-Cycle “Normal Valuation Analysis

Results of our valuation analysis for the end of November are summarized in Charts 23 through 33.

Exhibit 23

Exhibit 24

Exhibit 25

Exhibit 26

Exhibit 27

Exhibit 28 Exhibit 29

Exhibit 30

Source: Capital IQ and SSR Analysis

Exhibit 31

Exhibit 32

Exhibit 33

Source: Capital IQ and SSR Analysis


Our Skepticism Analysis by sector is summarized in the Exhibits 34 through 45.

Exhibits 34-36

Exhibit 34

Optimism High

Skepticism High

Exhibit 35

Exhibit 36

Optimism High

Skepticism High

Source: Capital IQ and SSR Analysis

Exhibits 37-39

Exhibit 37

Optimism High

Skepticism High

Exhibit 38

Optimism High

Exhibit 39

Skepticism High

Optimism High

Source: Capital IQ and SSR Analysis

Exhibits 40-42

Exhibit 49

Exhibit 41

Skepticism High

Optimism High

Exhibit 42

Source: Capital IQ and SSR Analysis

Exhibits 43-45

Exhibit 43

Optimism High

Skepticism High

Exhibit 44

Exhibit 45

Skepticism High

Optimism High

Source: Capital IQ and SSR Analysis

Research Published in January

January 20, 2014 – Optimists Won in 2013, but Are Now More Optimistic and Much More Expensive

January 15, 2014 – Chemicals Monthly: A Better Fundamental Year: Or Not Enough?

January 9, 2014 – Chemical Companies in 2014

January 6, 2104 – 14 for 14: 7 Attractive and 7 Overvalued Mid Cap Companies

January 5, 2014 – 14 Attractive, Bad or Over-Hyped Ideas for 2014

January 1, 2014 – Monthly Review January 2014: Charging Into the New Year


In Exhibit 46 we show a screen of stocks with low value, high Skepticism and high dividend yield. A month after falling out of the valuation screen, DuPont reappears on all three metrics, joining longtime holdover SWK, and OLN (which returns this month to the SI screen)

Exhibit 46

Source: Capital IQ and SSR Analysis

Appendix 1

Appendix 2

Appendix 3

Appendix 3

©2014, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. 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.

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