Monthly Review July 2013 – Midway Through the Year, Metals Still Searching For a Floor

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Graham Copley / Nick Lipinski



July 1st, 2013

Monthly Review July 2013 Midway Through the Year, Metals Still Searching For a Floor

  • Metals stocks were hit hard again in June, driven down by negative revisions and apparently slower Chinese growth. Only the Conglomerates and Packaging sectors were able to outpace the market for the month, as the Industrials continue to lag.
  • Paper’s underperformance for the quarter has trimmed almost one full standard deviation off its valuation premium, but it remains the most expensive of our covered sectors. The Metals sector is heading in the opposite direction, and now screens at a discount of more than two standard deviations to its normal value.
  • June research included an analysis of business complexity and return on capital volatility in the Industrials and Materials sectors and a corollary call on Caterpillar. The complexity/volatility work showed that the middle ground between the two extremes is favored in today’s market; CAT looks cheap in absolute terms and relative to its sector, and we believe the stock has limited downside at this point.
  • Our model portfolios provided strong returns for the month. We predictably had good success with our short picks in a down market, and our long side stocks produced small relative returns as well. The Overlap portfolio was once again the most robust with market outperformance of over 2%.
  • We would maintain our focus on the undervalued large cap group and we see further upside in DD. AA has become more attractively valued over the last month but weaker global demand growth may offset much better US demand.

Exhibit 1

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 2

Source: Company Reports and SSR Analysis

Appendix 3
for the data underlying this exhibit.

Exhibit 3


As the first half of 2013 comes to a close, the Industrial and Basic Materials sectors continue to struggle to keep pace with the market;
this has been our expectation since May
. Revisions drove the performance of the two biggest laggards in our group, Metals and Paper. Valuation might also have contributed to the decline in Paper, as the sector has been afforded a premium
for some time
. Concerns about a Chinese slowdown weighed on Metals shares.

The potential “tapering” of Federal Reserve asset purchases and the gradual curtailment of the free money environment roiled equity markets, and while the S&P rebounded, the Industrials were mainly left licking their wounds. Despite the Fed’s belief that the economy is gaining its own footing, midway through the year rail traffic demonstrates the sluggish pace of the ongoing recovery – total traffic is up 0.9% versus 2012. The valuation in the Transports space has been similarly stagnant, and revisions are neutral.

Newmont Mining (NEM) has been a casualty of the collapse in gold, and was the biggest loser in our group on the month, down 19%; three other Metals stocks joined it in the eight worst performers. Best and worst performers at the company level in our coverage universe are summarized in
Appendix 1

Sector performance relative to the S&P is shown in Exhibit 4.

The Conglomerates best weathered the market sell-off among the Industrials. Packaging was the only other sector to outpace the market in June. Transports were flat on the month. In the Chemicals space, underperformance in the Coatings and Agricultural Chemicals subsectors drove the group’s decline, even as the Commodity names (save DOW) hung in well.

Exhibit 4

Source: Capital IQ and SSR Analysis

Exhibit 5 summarizes end-June sector discounts from normal value.

The Paper sector has begun to come back into line from a valuation perspective; the group was at three standard deviations above normal in March but that premium has fallen nearly to two standard deviations after a quarter of underperformance. On the other end of the spectrum, Metals and Mining has risen back to two standard deviations below normal value after briefly falling below last month. Transports and Electrical Equipment continue to hover around one standard deviation expensive, while other sectors on the whole appear fairly valued. Within Transports, the premium is driven by the Trucking and Rail subsectors which stand at near term highs. Electrical Equipment’s valuation is pervasive within the sector, as six of the 16 stocks in our index screen at one standard deviation expensive. Capital Goods is the best value opportunity outside of Metals –
see recent research

Note: part of the reason why almost all of our sectors look expensive on a relative basis is because other sub-sectors of the S&P are undervalued versus history – most extremely and most notably financials.

Exhibit 5

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are summarized by sector in Exhibit 6. The underperformance of the Metals group has pushed the sector’s SI value above 2. Paper saw the biggest increase in the skepticism index for the month; returns remain high even as valuations have moderated. The E&C sector saw a large move up as well. The group’s ROC is nearly one standard deviation above normal but the sector is neutrally valued.

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.

Exhibit 6

Valuations Underestimating Current Returns on Capital

Valuations Overestimating Current Returns on Capital

Source: Capital IQ and SSR Analysis

Exhibit 7 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.

Most sectors and subsectors are grouped around the trend line in the exhibit, which shows all points where valuation and returns on capital are completely in line with one another, consistent with the results in Exhibit 6 which for the most part shows moderate skepticism index values. Metals is an obvious outlier in both exhibits. The Commodity Chemicals subsector is notable in Exhibit 7 as well; the group’s ROC is well above normal (2 SDs) but valuations do not reflect these above average returns.

Exhibit 7

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 1 of our June monthly. The results are summarized in Exhibit 8, showing performance relative to the S&P, which dropped 1.5% month over month.

The mid-month “taper” selloff was actually a boon for our portfolios which were producing strong returns through the first three weeks of June. The subsequent rebound trimmed some of those gains but the Normal Value and Skepticism screens still outpaced the market. The Overlap portfolio has typically been the most robust of the three screens, and was again in June, beating the S&P by over 2% for the month.

The short side was the main driver of the returns, with CMI and LPX standing out as notable decliners (down 10 and 15%, respectively). Metals stocks weighed on the long side picks as the already undervalued sector once again was the worst performing group in the Industrials.

Exhibit 8

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.

Fed Chairman Bernanke stated mid-month that the Federal Reserve could being to “taper” bond purchases towards year end provided the economy continues to gain traction. This announcement, though long anticipated, was evidently not being priced into global equity markets, which tumbled in the aftermath. The S&P 500 dropped nearly 5% before rebounding strongly into the month’s end. Bernanke’s comments and the subsequent fallout indicate that the price action in the stock market and the health of the economy remain at odds; raising interest rates as the economy finds its footing in support of itself is an appropriate action on the Fed’s part and an affirmation of a strengthening recovery, but the market seems to prefer that the free money environment continue in perpetuity (an inadvisable impossibility).

Manufacturing activity in China is decelerating and broader concerns have been raised about the burgeoning Asian economy’s sustainable growth levels. HSBC cut its forecasts for Chinese GDP growth. In Europe, the unfortunate status quo prevails; the CFO at large cap Conglomerate United Technologies highlighted the continent as a drag on revenue, which has been “a little bit worse” than anticipated. Honeywell’s CEO said at the Wall Street Journal CFO Network conference that the company is planning on “no growth in Europe” over the next three years.

The most recent Macro data changes are summarized in Exhibit 9.

Exhibit 9

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

Commodity Pricing

Metals pricing was volatile in June. Copper saw the biggest decline, over 7%. The metal last saw prices this low in June of 2010. For 2Q 2013 it is down 11%, the largest quarterly decline since Q3 2011. Concerns of a Chinese slowdown outweighed supply disruptions after Freeport McMoran was forced to shut operations at the world’s second largest copper mine in Indonesia. Aluminum also dropped sharply, nearly 6%, to levels not seen since 2009.

Natural gas fell firmly below $4/mmBTU for the first time since February. Crude prices were stable, widening the gas/oil differential.

US commodity prices and energy prices are indexed in Exhibits 10 through 14.

Exhibit 10

Exhibit 11

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

Exhibit 12

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 13

Exhibit 14

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

Expectation Analysis

In Exhibit 15 we look at expected net income growth by sector, comparing 2015 estimates with 2012 actual net income. The Capital Goods sector is still showing only a marginal three year increase in net income, highlighting not only continuing concerns about a slower growth future, but perhaps also a value opportunity in the space –
see recent research
. Paper was a poor performer on the month, and saw negative revisions to 2013 EPS estimates, but longer term optimism remains.

Exhibit 15 & Exhibit 16

Source: Capital IQ and SSR Analysis

Exhibit 17 shows how these longer term estimates have changed over the month. The Metals sector is the somewhat surprising outlier in the weighted rankings, but the increase is mainly due to cap weighting; a 5% increase in the unweighted estimate for FCX turned into a 10% gain in the cap weighted results as the stock accounts for a third of the sector’s market cap. The company’s recent investor day did not influence the near term stock price, but longer term estimates have clearly turned bullish. Most other sectors saw only marginal adjustments to net income estimates over June.

Exhibit 17

Source: Capital IQ and SSR Analysis

Revisions to 2013 EPS estimates in June were predominantly negative. The Metals sector saw downward revisions of 8%; year to date estimates have been slashed by one third. Estimates for Paper were notably down as well. Not coincidentally, these were the two worst performing sectors on the month. Most other sectors were only marginally revised.

Note that the numbers in Exhibit 18 differ from those in Exhibit 3 as the data is market cap weighted in Exhibit 18 and is a simple average in Exhibit 3.

Exhibit 18

Exhibit 19

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 20 through 30.

Exhibit 20

Exhibit 21Exhibit 22

Exhibit 23

Exhibit 24

Exhibit 25Exhibit 26

Exhibit 27

Source: Capital IQ and SSR Analysis

Exhibit 28

Exhibit 29

Exhibit 30


Source: Capital IQ and SSR Analysis


Our Skepticism Analysis by sector is summarized in the Exhibits 31 through 42.

Exhibits 31-33

Exhibit 31

Exhibit 32

Exhibit 33

Skepticism High

Optimism High

Optimism High

Skepticism High

Source: Capital IQ and SSR Analysis

Exhibits 34-36

Exhibit 34

Optimism High

Skepticism High

Exhibit 35

Exhibit 36

Skepticism High

Optimism High

Optimism High

Exhibit 36

Source: Capital IQ and SSR Analysis

Exhibits 37-39

Exhibit 37

Exhibit 38

Exhibit 39

Skepticism High

Optimism High

Source: Capital IQ and SSR Analysis

Exhibits 40-42

Exhibit 40

Optimism High

Skepticism High

Exhibit 41

Exhibit 42

Skepticism High

Optimism High

Source: Capital IQ and SSR Analysis

Research Published in June

June 3, 2013 – Monthly Review June 2013: Industrials Reflect the Housing Comeback

June 17, 2013 – Chemicals Monthly: A Mixed Month Midway Through 2013

June 19, 2013 – Complexity, Volatility and a Market Where Neither Extremes Work Well

June 19, 2013 – Time to Let the CAT Out of the Bag


In Exhibit 43 we show a screen of stocks with low value, high Skepticism and high dividend yield.

Exhibit 43

Source: Capital IQ and SSR Analysis

Appendix 1

Appendix 2

Appendix 3

Appendix 3

©2013, 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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