SSR Industrials & Materials Small-Mid Cap Rankings, February 2016

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

February 23rd, 2016

SSR Industrials & Materials Small-Mid Cap Rankings, February 2016

  • We update our small-mid cap rankings – the top 20 names are shown in Exhibit 1 along with the change in positioning from last month
    • WLK continues to screen well here: we have expressed specific concerns about polyethylene margins in 2016 and commented on the pending bid for AXLL in recent research
    • Modest turnover elsewhere in the list – truckers and machinery companies are again well-represented and strength in these groups has bolstered our results over the past few months
    • Disappointing guidance from rail car makers drove negative revisions and pushed TRN and ARII further down the list
  • We parse the universe into small-cap (<$3 billion) and mid-cap ($3-10 billion) – the top 10 names in each cohort are shown in Exhibits 2 and 3 on page 2
    • At the sector level, Exhibit 6 shows the top three stocks in each sector
  • Since 2012 the average 12 month performance of the top 20 stocks in any given month has been 2.3% in excess of the Russell 2000, with nearly identical results (+2.1%) versus the remaining Industrials & Materials stocks in our 150+ small-mid cap universe
    • These picks started out slowly but results in recent months have been robust
  • The small-mid cap analysis contains many of the screens we use in our broader large cap coverage modified slightly for the shorter, noisier data sets in the small cap names
    • These individual metrics are then combined (using weightings derived from detailed correlation analysis with forward performance) to give a weighted score
  • We provide these lists as possible fertile ground for those seeking ideas in the small-mid cap Industrials & Materials space
    • We will continue to refresh this analysis monthly and use it as a screening tool to identify specific names for further research

Source: Capital IQ, SSR Analysis

Overview

Aside from macro and sector specific fundamentals, our broad stock selection framework assesses sectors and stocks on four major dimensions – valuation, return on capital, capital allocation, and earnings estimates and optimism. We use that framework to identify anomalies which warrant further research that can hopefully lead to investible conclusions. In this monthly report, those four dimensions are applied to the small and mid-cap area. The universe analyzed encompasses 154 names in the Industrials & Materials sector with market caps below $10 billion (though a handful of names have snuck just above this mark since we began the analysis). We note that not all of these companies have full data sets (because of short lives as public companies) and have necessarily been excluded from some elements of the analysis – we expect to have closer to the full sample size represented in these tables as we continue to refresh them monthly. The ranking methodology has been back tested to 2012 – the top 20 ranked stocks in any given month have average 12 month performance 2.3% in excess of the Russell 2000. These results are also consistent if we compare the top 20 names to the remainder of the universe excluding those names. The weighting is shown in the Appendix. Below we have the same analysis as shown in Exhibit 1, but cutting the universe in half by market cap. This month the small cap group consists of names with cap below $3.4 billion.

Strictly Small Caps (market cap under $3 billion)

Source: Capital IQ, SSR Analysis

Mid Cap Group (market cap $3-10 billion)

Source: Capital IQ, SSR Analysis

Notes on Top Ranked Stocks

Positive earnings reports have lifted several of the recurring stocks from our small-mid cap lists – Exhibit 4.

Similar to what we have seen across the Industrials & Materials space during the past two earnings seasons, Truckers showed very strong earnings beats in Q4 on negative revenue comparisons, speaking to the strong pricing environment in the trucking industry. Regulatory concerns and availability of drivers are some of the factors that make trucking less attractive compared to rail over the long term, but the truckers have so far been able to effectively capture near term pricing gains from these dynamics. Fuel was also a tailwind in 2015 and should continue to provide benefits in the first half of ’16. This month’s top 20 list includes holdovers SAIA (up 16% year to date), ODFL (+7%), KNX (+2%) and LSTR (+0.3%). SWFT did not make the cut this month, but was previously a mainstay in the top 20 and has also enjoyed significant gains in 2016 (+34%). These performance results compare favorably to broad weakness in the small cap space as measured by the Russell 2000, down 11% thus far in ’16.

Machinery and equipment stocks likewise have been standout performers and several of these continue to populate the top 20 list. Longtime component Lindsay Corporation (LNN) fell just outside the top names this month, but has been one of the best recent performers in this Capital Goods group – up 18% versus a the Russell year to date. Agricultural machinery stocks has seen relative strength in 2016 to date and LNN fits in here for its irrigation systems, which represent 80% of company sales. Toro Corp (TTC) has a similar but smaller exposure to agricultural irrigation. The company is better known for its presence on the links, with a line of mowers, maintenance equipment, and irrigation systems designed for golf courses – the stock is up 20% over the past month. Generac (GNRC, a company we highlighted in this section in a prior issue of this report) was up sharply on earnings and Lincoln Electric (LECO) has made a nice run heading into its earnings release on Tuesday. All told, these results have more than offset recent weakness in the rail car makers, which themselves had managed to stay ahead of a weak small cap space until disappointing guidance drove shares lower.

Exhibit 4

Source: Capital IQ, SSR Analysis

Sector Analysis

Exhibit 5 shows the composition of the universe of small-mid cap stocks and Exhibit 6 lists the top three ranking names in each sector, based on the overall analysis in Exhibit 1. The composition is not dissimilar to that of our overall Industrials & Materials universe.

Exhibit 5

Source: Capital IQ, SSR Analysis

Exhibit 6

Source: Capital IQ, SSR Analysis

Appendix

On the following page we show a graphical representation of our analytical framework. The components are interconnected and include:

  • Valuation
    • The valuation work for our full universe of stocks is heavily based on a company’s long term return on capital. For these small cap names we often have insufficient data histories to utilize our ROC based models, so we here look at EV/EBITDA (forward) and Price/Book.
  • Return on Capital
    • We still consider return on capital but the data set is pulled from Capital IQ on a quarterly basis as opposed to the monthly, model generated, figures that we typically use. Please refer to our prior research reviewing our methodology and models in greater detail.
  • Optimism & Earnings Revisions
    • We have done extensive work on corporate optimism, finding that companies with management teams that are consistently over-optimistic about their prospects underperform considerably and erode returns on capital in the long term – see our piece on the topic specifically.
  • Capital Allocation
    • For the small cap companies here we look at two trailing metrics, three year average TSR and dividend yield. We assign a negative weight to the dividend yield, which has a negative correlation with forward performance for this group.

Weighted Score by Company (ranked best to worst):

©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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