Weaker Global GDP Suggests Some Heroic Estimates/Expectations

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

December 9th, 2014

Weaker Global GDP Suggests Some Heroic Estimates/Expectations

  • Almost daily negative revisions on GDP expectations for 2015 for almost every region outside the US, are a cause for concern. If correct they will drive real challenges for companies with heavy non-US exposure in 2015, not only from a demand growth perspective, but also from an exchange rate perspective as the US dollar is likely to remain high.
  • Despite the rhetoric of the new leadership and the cost cutting opportunity, APD looks quite vulnerable on this basis because expectations are high and non-US exposure is very high. Others we would be concerned about would include ALB (as the ROC acquisition is beginning to look quite expensive), CYT, LECO, DHR and GGG.
  • With the exception of CYT, none of the expensive names have overly heroic estimates for 2015 based on their history, but all have valuations that suggest estimates are too low. APD and CYT have the worst history when it comes to overestimating earnings. CYT has the growth in the aerospace sector and APD has cost opportunity, but both are very richly valued.
  • However, as a risk, we would question the current economic sentiment and worry that the current negative revisions are a lagging indicator. Historically, significantly lower crude oil prices have provided a global economic boost, as importing oil countries tend to be more populous than the exporters and lower oil means higher levels of cash for other spending.
  • If the economic sentiment is not correct, and growth is higher, we would want to look at stocks with high non-US exposure and low values – these would include many of our current favorites, like DD, CAT, SWK, DE, PX, and EMN.
  • We have highlighted the valuation disconnect between PX and APD in recent research and show the deviation again in Exhibit 1.

Exhibit 1

Source: Capital IQ and SSR Analysis

Overview

Outside the US, negative GDP revisions seem to be in vogue and we seem to get a new negative signal every day – some of the recent moves are summarized in Exhibit 2. This is a negative for companies in two ways, in that growth expectations for businesses outside the US become more muted and overall this is having a positive effect on the US dollar, resulting in translation impacts on P&Ls.

Exhibit 2

Source: Bloomberg

The negative GDP revisions are counterintuitive based on the likely positive impact of lower crude prices on crude importing countries/regions. Using Brent as a reference, crude prices are down more than 40% from their peak earlier this year. Some of that has been offset by the higher dollar for most importing countries. It is possible that recent GDP revisions turn out to be a lagging indicator and that 2015 economic growth is better than current very low expectations.

However, if expectations are correct, we should be wary of companies where non-US exposure is high and where valuation discount improvements over current consensus expectations. The chart in Exhibit 3 shows companies with a negative Skepticism Index and non US exposure. Negative Skepticism = Optimism and indicates that valuations anticipate improvements in returns of capital that are not reflected in forward 12 month estimates. It will be hard for these companies to meet the expectations implied in valuation, with a strong non-US headwind and a currency headwind.

Exhibit 3

Source: Capital IQ, SSR Analysis

We have included companies where valuation is supported by an announced acquisition, and would note that both Merck KGaA and Albemarle may face some challenges with their acquisitions (SIAL and ROC, respectively), given non-US exposure and the prices they are paying.

Standouts on the chart would be the companies in the upper left corner, and include; APD, CYT, DHR, LECO and GGG. All derive more than 50% of their revenues from outside the US and all are pricing in real improvements in earnings, above and beyond 12 month forward estimates.

Earnings and Estimates

APD has the highest expected earnings growth in this group, but it does not appear overly optimistic relative to the company’s history over the past decade. Estimates for DHR and GGG look reasonable as well, while CYT and to a lesser extent LECO are anticipating growth in excess of their longer term annual averages – Exhibit 4.

Exhibit 4


Source: Capital IQ, SSR Analysis

Of these names, APD and CYT have had the best earnings revision trends during 2014, but both of these companies show a historical tendency to overestimate – Exhibits 5 and 6. 2015 estimates have come down by more than 4% over the course of the year for Graco, Danaher and Lincoln Electric. On the optimism front – DHR has been the most consistent earnings estimator. The results for GGG and LECO are not skewed by any singular outliers, as these companies have produced double digit beats over the initial estimate on multiple occasions since 2010.

Exhibit 5

Source: Capital IQ, SSR Analysis

Exhibit 6

Source: Capital IQ, SSR Analysis

We show a breakdown of the Skepticism Index for APD, CYT, LECO, DHR and GGG in the exhibits below.

Exhibit 7

Source: Capital IQ, SSR Analysis

Exhibit 8

Source: Capital IQ, SSR Analysis

Exhibit 9

Source: Capital IQ, SSR Analysis

Exhibit 10

Source: Capital IQ, SSR Analysis

Exhibit 11

Source: Capital IQ, SSR Analysis

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