SSR Industrials & Materials Monthly Review, December 2016: All About the New Year with Deep Value in Play

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Graham Copley / Nick Lipinski



January 3rd, 2017

SSR Industrials & Materials Monthly Review, December 2016:

All About the New Year with Deep Value in Play

  • 2017 estimates and relative valuation moves suggest 2016 may have been the bottom for several of the most cyclical subsectors within Industrials & Materials
    • 2016 EPS revisions were an inverse predictor of stock performance for Industrials & Materials – forward (2017) estimates ex-metals show more concern over earnings than reflected in valuation moves and may be more exchange rate driven than fundamental
    • Many sectors began 2016 at (Metals, Capital Goods) or near (Electrical Equipment, Paper & Packaging) post-recession valuation troughs and are now well off these lows
  • Most loved sectors of 2016:
    • Stock performance – the Metals sector was top performer even before Trump rally, good for a one standard deviation move in relative valuation – this remains the cheapest sector in our coverage but the recent quick move higher could lead to some retracement if Trump bump policies falter; Chinese production remains a wild card for pricing for all metals
    • EPS revisions – Conglomerates estimates held in best, off only 3% versus initial consensus
    • Recommendations – despite largely plus market performance and generally higher 2017 estimates, analysts grew more bearish on all of our sectors – Electrical Equipment least changed on this metric
  • Most unloved sectors of 2016:
    • Stock performance – Chemicals were held back by inaction in the large cap names (DOW, DD, MON) where deals are pending – despite concerns in the Coatings and Industrial Gas subsectors, we remain overweight the sector in aggregate – LYB is large cap stock with significant potential upside
    • EPS revisions – Metals estimates fell throughout the year, but consensus for 2017 and the performance noted above suggest this may have been the bottom
    • Recommendations – Metals/E&C/Paper & Packaging – average sell side recommendation grew more bearish by the greatest magnitude in these sectors – another suggestion for a bottom in Metals given the historical record of recommendations
  • December research included work on:
    • Praxair – merger with Linde may a better long term option than the alternatives, but immediate action in the share price is unlikely to be positive – prefer Air Liquide in the space
    • Capital Spending – Brexit and Trump likely to constrain capital spending in the near term – opportunities for cash deployment to shareholders – some commodities may tighten faster
    • LYB – several reasons to pay attention – underappreciated trough earnings, ample cash and shareholder favorable deployment strategies, sell-side disbelief
  • Exhibit 1 summarizes our preferences by sector and stock
    • DOW/DD and MON remain our favorites

Exhibit 1

Exhibit 2

Source: SSR Analysis – Normal Value looks at valuation relative to historical norms and the SI 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

See Appendix 3 for the data underlying this exhibit.

Exhibit 4


Our early 2016 prediction that our sectors would be unloved in 2016 because of overly optimistic earnings expectations turned out to be partly right, but completely wrong in the only way that mattered – the stocks outperformed! We were right on revisions as shown in the left hand chart in Exhibit 5 – the stocks performed despite declining earnings. For the most part 2017 earnings revisions were also negative and if Metals are removed from the right hand chart there is no correlation at all. However, our valuation and skepticism measures of stock attractiveness have had their best year ever (including the period when we were just looking at Chemicals from 1990 to 2004 (Exhibit 10), and this underscores a dramatic return to value based investing as 2016 progressed – away from the momentum drivers of 2014 and 2015.

Likely co-incident with the election and the bi-partisan focus on infrastructure, there is clearly an investor sense that industrial production is going to pick up in the US and that we might be at the bottom of an industrial cycle – setting up for a major cyclical recovery. This is most aggressively reflected in the construction material names, which in some cases are already reflecting higher forward earnings peaks than we have seen in any prior cycle. The improving valuation while estimates (ex-metals) continue to fall is not inconsistent in our view. A boost in US spending will not come immediately and some ground work will need to be laid first in terms of policy and priorities. In the meantime, multinationals have to tackle the stronger dollar which will inevitably be a headwind in 2017.

Exhibit 5

Source: Capital IQ and SSR Analysis

The sell-side is very estimate focused and it is not surprising that the revisions have caused a more bearish drift in recommendations, Exhibit 6, but we would be tempted to look through this, as a step up in US investment, whether driven by infrastructure or by the redeployment of repatriated offshore cash, will float most boats. Some of our more favored stocks today are at recent lows in terms of sell-side support – LYB for example.

Exhibit 6

Source: Capital IQ and SSR Analysis

Additionally, we do not see the negatives in December as a cause for concern, given the overall strength of the second half of the year – more likely some profit taking on stocks that have done well. The risk of course is that all of this positive industrial rhetoric in the US comes to nothing and that Washington gridlocks over infrastructure and offshore cash repatriation. In this instance the dollar may weaken, but with the rest of the world uninteresting from a growth perspective we could have a reversal of 2016 in 2017, with those sectors that have done the best in 2016 most vulnerable.

Sector performance in December and for 2016 in total is shown in Exhibit 7. We show the 25 best and worst performing stocks on these time frames in Appendix 1.

Exhibit 7

Source: Capital IQ and SSR Analysis

Exhibit 8 summarizes discount from normal value by sector. Several sectors, notably Capital Goods and Metals, began 2016 at or near post-recession valuation lows but moved off these lows throughout the year.

Exhibit 8

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are summarized by sector in Exhibit 9 (see our skepticism work for more detail).

Exhibit 9

Source: Capital IQ and SSR Analysis

Exhibit 10 is a very busy chart but shows how each sector and sub-sector breaks down by skepticism index 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. Coatings remains an outlier because of SHW – within the sector we are more positive on RPM and AXTA.

Exhibit 10

Source: Capital IQ and SSR Analysis

Portfolio Performance

2016 was a strong rebound year for our portfolio selection methodology – Exhibit 11. See accompanying work out today.

Exhibit 11

Source: Capital IQ and SSR Analysis

An alternative portfolio approach is based on our expanded skepticism index performance analysis which showed a very attractive risk-reward relationship for stocks with positive SI values, valuation discounts, and positive 3 month EPS revisions. This month we have a list of 20 stocks that fall in these historically outperforming ranges – Exhibit 12.

Exhibit 12

Source: Capital IQ and SSR Analysis

Exhibit 13 shows the historical forward performance of the stocks meeting the criteria in Exhibit 11 at various ranges. We note that for all ranges where the SI is above 0.5, the average return is in excess of the variability (average > standard deviation).

Exhibit 13

Source: Capital IQ and SSR Analysis

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.

Despite a slight tick down in US business confidence and industrial production, the business outlook heading into 2017 is relatively solid and stable. The health of the domestic economy was cited as a justification for a second small rate hike from the Fed. Elsewhere we see a broad improvement in the employment picture in peripheral Europe.

Exhibit 14

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

Commodity Pricing

Copper has mostly held its post-election gains, and steel pricing has rebounded to recent highs as well. Aluminum pricing has been relatively stable but the supply/demand picture here remains the best among major industrial metals. Continued recovery in energy pricing with crude settling in in the mid $50s/barrel range on OPEC’s output accord and natural gas approaching $4.00 per MMBtu on cold weather forecasts.

US commodity and energy prices are indexed in Exhibits 15 through 19.

Exhibit 15                                                                                     Exhibit 16

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

Exhibit 17

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 18                                                                                     Exhibit 19

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

Expectation Analysis

In Exhibit 20 we look at expected net income growth by sector, and in Exhibit 21 we plot the growth figure against each sector’s current skepticism index value. Note that we have excluded the Metals sector from these exhibits as the temporary removal of AA has left the groups’ 2015 net income base below 0.

Exhibit 20                                                                                      Exhibit 21

Source: Capital IQ and SSR Analysis

Exhibit 22

Source: Capital IQ and SSR Analysis

Exhibit 23 shows 2017 EPS revisions over the past month and Exhibit 24 plots these revisions versus performance results on the month. US Steel and Cliffs saw significant positive revisions in December, +50% and +20% respectively, to drive the Metals group. Revisions were mostly modest elsewhere, and most negative in the Chemicals space due to CF (-7%), WLK (-4%), and VAL (-11%). The VAL revision came as the company reported higher costs leading up to the pending SHW acquisition.

Exhibit 23                                                                                     Exhibit 24

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

Mid-Cycle “Normal” Valuation

In Exhibits 25-34 on the following pages we show the historical current discount/premium to normal mid-cycle value by sector.

Exhibit 25

Source: Capital IQ and SSR Analysis

Exhibit 26

Source: Capital IQ and SSR Analysis

Exhibit 27

Source: Capital IQ and SSR Analysis

Exhibit 28

Source: Capital IQ and SSR Analysis

Exhibit 29

Source: Capital IQ and SSR Analysis

Exhibit 30

Source: Capital IQ and SSR Analysis

Exhibit 31

Source: Capital IQ and SSR Analysis

Exhibit 32

Source: Capital IQ and SSR Analysis

Exhibit 33

Source: Capital IQ and SSR Analysis

Exhibit 34

Source: Capital IQ and SSR Analysis


Our Skepticism Analysis by sector is summarized in the Exhibits 35 through 45.

Exhibit 35

Source: Capital IQ and SSR Analysis

Exhibit 36

Source: Capital IQ and SSR Analysis

Exhibit 37

Source: Capital IQ and SSR Analysis

Exhibit 38

Source: Capital IQ and SSR Analysis

Exhibit 39

Source: Capital IQ and SSR Analysis

Exhibit 40

Source: Capital IQ and SSR Analysis

Exhibit 41

Source: Capital IQ and SSR Analysis

Exhibit 42

Source: Capital IQ and SSR Analysis

Exhibit 43

Source: Capital IQ and SSR Analysis

Exhibit 44

Source: Capital IQ and SSR Analysis

Exhibit 45

Source: Capital IQ and SSR Analysis

Research Published in December

December 21, 2016: Praxair – Linde: Keeping Everyone Happy, Except Perhaps the Shareholders

December 19, 2016: Mosaic – A Necessary Move, But Value Unclear

December 16, 2016: Chemicals Monthly – Negative Revisions, Positive Performance on Par With Year of Trump

December 12, 2016: Tr-Uncertainty and Br-Uncertainty: Whither Capital Spending?

December 12, 2016: LYB – Several Reasons to Pay Attention

December 9, 2016: Paint Wars – A Reminder and Some Fresh Perspective

December 2, 2016: Praxair – Compensating For Lack Of Growth!


In Exhibit 46 we show a screen of stocks with low value, high skepticism and high dividend yield. CF and HUN have fallen out of this overlap, leaving only EMN, OLN, and PKG.

Exhibit 46

Source: Capital IQ and SSR Analysis

Appendix 1

Appendix 2

Appendix 3

Appendix 3

©2017, 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.

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