SSR Industrials & Materials Monthly Review, July 2016: Earnings Show an Environment of Spotty Strength

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Graham Copley / Nick Lipinski



August 1st, 2016

SSR Industrials & Materials Monthly Review, July 2016:

Earnings Show an Environment of Spotty Strength

  • Earnings reports have been markedly mixed in both tone and results
    • Most corporate commentary confirms a generally lackluster global growth engine
      • Industrial production and manufacturing activity challenged across the world
      • US consumer spending strong in pockets – auto slowing in the US, more bullish in Asia
    • DOW appears to be in the sweet spot right now, with specialty applications enabling it to outgrow its regional markets and rising living standards in emerging Asian economies driving robust growth in consumer and automotive end markets
    • Conversely, EMN’s specialty end markets came under continued pressure in Q2 – see research
  • Metals stocks outperformed as results came in ahead of expectations
    • Trade duties are benefitting domestic steel makers, while miners are seeing gains from higher commodity prices
    • Only E&C stocks posted a larger gain for the month, rising ahead of earnings reports
    • Positive reports drove stocks higher in the Packaging and Transports sectors – positive indicators for the US
    • Conglomerates showed the strongest year over year revenue growth of our sectors but underperformed relative to the group and the market as guidance underwhelmed – excluding GE, these stocks continue to show the largest premiums in Industrials & Materials
  • M&A remains in focus as a growth driver in an economic environment currently starved for growth
    • MON posted the weakest combination of EPS and revenue results relative to expectations in our entire coverage, which does not strengthen its bargaining position
    • JOY’s takeout by Komatsu creates a holistic mining competitor for CAT
  • Over the past month we have published research on:
    • Ethylene – potential for near-term revisions could lead to better entry points here – see research and recent blog
    • Europe – we are cautious on Europe given not only the destabilizing Brexit, but its potential knock-on effects, the risks of which have yet to be fully reflected in valuations or estimates
    • Yield – identifying companies in Industrials & Materials that could qualify as unconventional “bond proxies” and benefit from yield seeking behavior, as well as those that have the potential to do so
  • Exhibit 1 summarizes our preferences by sector and stock
    • DOW and DD remain our longer-term favorites in the Chemical space and Industrials & Materials generally, though we clearly have a positive view of MON near term
    • If our “Brexit” take is correct and if natural gas keeps rising, all could get cheaper near-term

Exhibit 1

Source: SSR Analysis

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


Top line results in Q2, with 80 or our 116 covered companies having released results, show a broadly positive trend at the sector level. Revenue growth is turning less negative for most sectors in 2016 after a challenging 2015 – Exhibit 5 – though the lackluster results in ’16 to date in the face of easing currency comparables underscores the pervasive environment of low growth. The Conglomerates sector has been the best insulated in recent quarters and grew revenue at the fastest pace in our group in Q2, but of the big four (GE, HON, UTX, and MMM) only UTX stock rose after reporting earnings, as guidance, while mostly in line for ’16, underwhelmed investors that were expecting more to justify the premium stock valuations (particularly ex. GE). The negative revision figure in Exhibit 4 mostly reflects a pending spinoff at DHR and the associated earnings gap.

Exhibit 5

Source: Capital IQ and SSR Analysis

A more robust global demand landscape may have enabled stronger results versus the currency depressed figures of 2015. A disappointing US GDP figure, weak industrial production seemingly across the globe, and the added uncertainty of Brexit layered onto a still struggling Europe had multiple companies discussing M&A (mostly bolt-on) as a driver of growth in the absence of a macro tailwind. The biggest pending deal in our space (outside DowDuPont, which was recently approved by shareholders) remains Bayer-Monsanto. MON’s position in Exhibit 6 below does not give it much leverage in its negotiations with prospective buyers – we believe the company should have accepted Bayer’s offer by now, that the likelihood of a deal diminishes as the delay drags on, and that the stock would have significant downside in the case that it falls through. Exhibit 6 also highlights the pockets of growth that exist in select end markets and regions, best exemplified by DOW. The company is clearly benefitting from its focus on higher value-added specialty applications, as well as its exposure to Asian markets where rising standards of living have provided major tailwinds in automotive and consumer related end markets.

AA, WOR, and NEM were leaders in the Metals space, where companies largely posted better than expected earnings results and upbeat guidance led to positive revisions. Alcoa remains bullish on aluminum demand. WOR was one of several domestic steel manufactures to cite duties on Asian steel as a positive – peers X and ATI were the best performing stocks in our universe on the month, and the remainder of the list of outperformers is dotted with Metals stocks. OLN was the clear laggard in our group – the stock’s -16% move on the month was 10 percentage points below the next worst performing stock – and remains our favored short in the commodity chemicals space. EMN was also among the worst performers in July, and it is not clear that the company has a quick fix for what is ailing it – see research out today. We show the 25 best and worst performing stocks in our coverage for the month in Appendix 1.

Exhibit 6

Source: Capital IQ and SSR Analysis

Sector performance relative to the S&P for the month is shown in Exhibit 7. E&C stocks were up big ahead of earnings. Positive earnings results drove Packaging and Transports (mostly rail) stocks higher.

Exhibit 7

Source: Capital IQ and SSR Analysis

Exhibit 8 summarizes discount from normal value by sector. The Metals sector is about one standard deviation off its discount from the start of the year but remains the cheapest in our group, which is broadly inexpensive outside of the Conglomerates. Rising rail valuations are pushing the premium higher in the Transports sector.

Exhibit 8

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are shown by sector in Exhibit 9 (see our skepticism work for more detail). Positive revisions in recent months have brought returns closer to trend for the Metals group, which continues to discount earnings weakness. Paper & Packaging also appears to be discounting negative revisions even though earnings reports have been largely positive. The negative SI value in the Transports is driven by the Trucking group – see Exhibit 10 below.

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. Trucking is the only group in the concern area.

Exhibit 10

Source: Capital IQ and SSR Analysis

Portfolio Performance

The overlap of our traditional valuation and skepticism based portfolios (see Exhibit 2) produced cumulative monthly gains of 15.6% in 2013 and 9.8% in 2014, but was far less successful in 2015. Our return on capital based models that produce the portfolio selections assume cyclicality and fail to capture the secular changes impacting an industry – a major issue for many Metals and Commodity Chemical stocks. FCX, CLF, HUN, and OLN were among the mainstays on the long side throughout the year and condemned our portfolios to a year of underperformance.

To begin 2016, and particularly in recent months, commodity stocks rallied and our portfolios benefitted accordingly – July has been another strong month, again buoyed by Metals stocks, but also KSU and PKG in the overlap group.

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 21 stocks that fall in these historically outperforming ranges – these are summarized in Exhibit 12 and include six Paper & Packaging stocks (PKG, IP, OI, GEF, UFS, and CCK).

Exhibit 12

Source: Capital IQ and SSR Analysis

Exhibit 13 shows the historical forward performance of the stocks meeting the criteria in Exhibit 12 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.

US Q2 GDP was marked down again, to a sub-2% figure. The consumer continues to spend, though slowing auto sales, the largest component of retail spending, could pose a challenge moving forward. Business investment remains constrained. The Brexit puts an additional level of uncertainty on the European recovery, as it were, which has struggled to produce even the disappointing 2% growth seen in the US. The next political event to monitor is Italy’s referendum on governmental reforms set for October – if this fails, Italian PM Renzi has pledged to step down ala Cameron, which could thrust an extremely euro-skeptic party into power. In emerging markets, China is working through its growing pains, while conditions in Latin American appear to be at a trough, though few are actively calling for a quick recovery.

Exhibit 14

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

Commodity Pricing

Steel pricing was off 9% in July but remains up 45% on the year and is up 15% versus prior year levels. Year to date gains in copper and aluminum have been far more muted (+6% for aluminum after a 2% decline on the month, +3% for copper after a 1% July gain). Natural gas prices were volatile on the month but ended little changed in the $2.90 per mmbtu range. Crude meanwhile, fell to the lower end of the recent $40-50 range, a 13% decline on the month. The Baker Hughes North American rig count has showed gains for five consecutive weeks.

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

Exhibit 15

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

Exhibit 16

Source: IHS, SSR Analysis

Exhibit 17

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 18

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

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. We note that the Metals result is higher than the chart indicates and reflects a very low 2015 base. Paper & Packaging leapfrogged Chemicals and Conglomerates in the ranks on strong positive revisions that were second only to those seen in the Metals space – Exhibit 22 shows the change to longer-term net income estimates over the month. Outside the two positively revised sectors, revisions were marginally negative, most notably so in Chemicals and Conglomerates.

Exhibit 20                                                                          Exhibit 21

Source: Capital IQ and SSR Analysis

Exhibit 22

Source: Capital IQ and SSR Analysis

Exhibit 23 shows 2016 EPS revisions over the past month and Exhibit 24 plots these revisions versus performance results on the month. Paper & Packaging revisions were led by UFS (+17%) which posted a strong Q2 beat. Note the averages in Exhibit 24 are simple geometric averages versus the cap weighted results shown in Exhibit 4. In the simple average results shown here, a large negative revision for CLF offsets positive changes for AA and NEM. OLN and MOS are the biggest Chemical culprits, while we note again the Conglomerates results reflects a DHR spinoff.

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 July

July 27, 2016 – Ethylene: The US Remains the Center of Attention (blog)

July 21, 2016 – “Bond Proxies” 2.0: Dressing up for Income

July 19, 2106 – Monsanto: “A Bird in the Hand” – Hit the Bid – Now!

July 18, 2016 – Chemicals Monthly: Brexit Bad for Chemicals, With a Few Possible High Yield Exceptions

July 15, 2015 – Monsanto/Bayer: Brexit Raises a Significant Currency Problem (blog)

July 13, 2016 – Europe: Hard to See When/Whether the Mood Will Turn Positive

July 13, 2016 – Bond Proxies in Industrials & Materials: Surely Not!

July 5, 2016 – Ethylene: You Can’t Fight the Fundamentals


In Exhibit 46 we show a screen of stocks with low value, high Skepticism and high dividend yield. This month CF and EMN join three holdover companies from the past three months: HUN, OLN, and PKG.

Exhibit 46

Source: Capital IQ and SSR Analysis

Appendix 1

Appendix 2


Appendix 3

Appendix 3

©2016, 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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