SSR Industrials & Materials Small-Mid Cap Rankings, March 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

March 21st, 2016

SSR Industrials & Materials Small-Mid Cap Rankings, March 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
    • Six companies are new to the list this month, concentrated in the Chemicals (BCPC, CE, FOE) and Capital Goods (CR, LNN) sectors
    • WLK continues to screen near the top – we wrote positively on its proposed deal with AXLL last month, and see the stock as attractive irrespective of the outcome
    • Truckers remain well represented and are on the rise – LSTR, KNX, ODFL – railcar makers are generally trending in the opposite direction – TRN, ARII, despite top-ranked GBX
  • 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 7 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 following our initial publication, 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 $3.3 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

An uncertain outlook and a host of thematic issues have spurred recent activity in the chemical industry, and more deals seem likely. The sector is well represented in our small-mid cap analysis (WLK and NEU are top ranked holdovers) and chemical companies entering the top-20 rankings this month included Celanese (CE), Balchem (BCPC), and Ferro Corporation (FOE), all with specialty offerings.

Truckers continue to populate our small-mid cap lists and stocks have performed very well in Q1 ’16 after falling out of favor in 2015. LSTR, ODFL, KNX, SAIA, and SWFT are all names that have been top ranked recently (all but SWFT make appearances this month) and all are up double digits year to date – SAIA the leader (+33% versus the Russell 2000) and KNX (+14%) the least-best performer. The situation is reversed in the railcar manufacturing sector, where performance has been underwhelming and the stocks are generally trending lower in the overall ranking – TRN and ARII sliding down in the top 20 for the second consecutive month, though GBX tops the list this month. GBX and ARII still screen well in the isolated small-cap group, and the industry itself has positive long-term fundamentals given the likelihood of incremental freight gains for rails at the expense of trucks.

Tool maker Snap-On (SNA), which breaks into the top 10 mid-caps this month, is at the high end of the mid-cap universe (equity capitalization of ~$9 billion) and lends itself better to our long-term, return on capital trend based normal earnings models than many of the smaller names that have less history. The stock was a longtime investor favorite, rising nearly linearly from $60 in mid-2012 to $170 in mid-2015, but organic growth has begun to fade against increasingly challenging comparable figures – Exhibit 4. The stock is off its highs but still looks expensive on normal earnings.

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5


Source: Capital IQ, SSR Analysis

Sector Analysis

Exhibit 6 shows the composition of the universe of small-mid cap stocks and Exhibit 7 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 6

Source: Capital IQ, SSR Analysis

Exhibit 7

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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