Weekly Findings – December 23rd, 2018

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

FOR IMPORTANT DISCLOSURES 203.901.1629 / 203.901.1627

gcopley@ / asalzillo@ssrllc.com

December 23rd, 2018

Weekly Findings – December 23rd, 2018

Thought for the week: “Sometimes you just get it wrong! Otherwise, Happy Holidays”

  • Chart of The Week – Optimism Destroys Value – FDX Example
  • Spectacular Failure = More Opportunity
  • Weekly Winners & Losers

Chart of the Week

Note: Unless there is compelling news, we will not publish next Sunday

  • Chart of the Week – Optimism Destroys Value – FDX Example

We have a substantial body of work on business optimism and the destructive effect that it can have on corporate performance and shareholder returns. In our original analysis 6 years ago, we identified FDX as one of the worst offenders – well within the lowest quintile of the 120 companies we analyzed. At the time we took some flak for this conclusion – specifically for FDX from portfolio managers that were big believers in the story. Subsequently, we were somewhat vindicated as the company missed estimates badly in 2013 and 2014, the two years that immediately followed the early work. Now the company has done it again, with the fiscal 2019 bar in the chart below representing where estimates have moved to since the earnings warning, but this time the stock punishment has been severe as the chart of the week shows – wiping out most of the outperformance that FDX has generated since 2002.

FDX has had a good history of growth – charts below – with EPS growth averaging 13% from 2002 to 2019 (estimate), much better EPS growth than the market or many of its Industrial peers.

The latest revisions have turned return on capital estimates down – chart above, but the company is still above a positive trend line and very few companies of FDX’s size have a positive trend.

Despite the earnings growth, the uncertainty and risk crated by the optimism – if you look at an average optimism measure from fiscal 2003 to when we did the original analysis and then from 2003 to today, the average has deteriorated incrementally – so overestimation has been worse since 2012. It is possible that fiscal 2019 is a one off caused by events that the company could not have predicted (sometimes you just get it wrong) – but FDX has a pattern of behavior and a long history. The consequence is that the stock is inexpensive – first chart below – caused by a deterioration in relative multiple – second chart. The second chart is interesting as (ignoring the recent collapse, which has happened as the S&P multiple has also collapsed) there are plenty of lower quality large cap companies in the Industrial and Materials sectors – with lower average EPS growth than FDX but with better relative multiples. Most of these companies do not fail out “optimism” test.

With a better narrative – more realistic assumptions around expectations – more conservative guidance and more consistency versus expectations, FDX has significant multiple upside, despite the current earnings problems. This is now becoming a very inexpensive stock. We would be buyers at current valuation.

  • Spectacular failure – last week’s recommendations

Last week we suggested three chemical names worth buying – ALB, KWR and VSM. It is not clear that we could have picked a group with a worse subsequent 1-week performance had that ben our goal – chart! To be fair, last week was spectacularly bad for the market and anything that could be tied to energy did especially poorly (which should not have included this group) – see last chart in this email. Energy is weaker because of lower demand projections because of lower economic growth projections. None of the ideas we presented last week were solely economic growth dependent:

  • ALB is an emerging technology story (electric vehicles) with an added belief that the company has probably secured the sale of its catalyst business to fund current and future Lithium investments
  • VSM is an anticipated consolidation story – in what is otherwise a strong underlying industry from a secular growth perspective
  • KWR is an acquisition integration and synergy story.

None of the logic behind what we wrote last week has changed – the opportunities are just more interesting because of valuation.

  • Weekly Winners and Losers

©2018, 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. Sources: Capital IQ, Bloomberg, Government Publications.

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