- The metals sector remains attractive in our valuation framework, and at the larger cap company level the appeal is broad, with the best only fairly valued, and most well below fair value. This suggests that a basket approach owning the group is appropriate.
- Return on capital analysis when compared with valuation analysis shows the group to be outside the historic range meaningfully; suggesting that either relative valuation will improve or returns will fall. In other words, skepticism is very high.
- As indicated in our initial report, we think that this valuation discount is driven by near-term price movements and cyclical concern about demand as it relates to China. Industry specific metrics are good – returns are high, though declining from a cyclical peak, cash flow is good and balance sheets are conservative.
- While cheap stocks and sectors can always get a bit cheaper, we see as much as 35% upside as the sector normalizes in value. Within the group there are individual companies that offer as much as 45-50% upside. For the sector to move to extreme historical cyclical lows there is around 16% further relative downside (which is not insignificant), but we do not see industry fundamentals that would support that.
- In the chart below we introduce a skepticism measure. Reflecting ROC deviations and premium/discount from normal value based on our valuation framework, this skepticism measure confirms our overall conclusion of undervaluation in the Metals and Mining sector.
Source: Capital IQ and SSR Analysis