SMID Cap I&M – Some Still Cheap Stocks with Momentum and Some Expensive Laggards

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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

August 18th , 2017

SMID Cap I&M – Some Still Cheap Stocks with Momentum and Some Expensive Laggards

  • We update our return on tangible capital work for a group of ~120 SMID cap Industrials & Materials stocks and find some attractively valued names with earnings momentum
  • TSE remains a clear attractive standout on valuation (return on tangible capital relative to enterprise value – Exhibits 2 and 3)
    • Year over year volumes improved compared to Q1 and the company’s revenue surprise was among the 15 highest in the group (the company missed earnings but held guidance)
  • VSM is a high ROTC name that looks undervalued in our view
    • Volume growth was impressive (+21% after +18% in Q1), the company produced a robust combination of top and bottom line surprises versus consensus, and there could be a long runway here with high operating leverage
  • AXTA’s struggles were not unusual relative to peers in the Coatings space where we are generally concerned about the possibility of peaking valuations
    • Stock has downside to return on tangible capital, earnings and revenue both missed estimates, and volumes and pricing are moving in the wrong direction
  • Trucking stocks have disappointed and screen expensive – HTLD, SWFT, and KNX
  • We have seen one of the best quarters in a while for revenue surprises and revenue growth, despite significant underperformance from the large cap group since early July
    • Exhibit 1 summarizes the revenue beats and misses, with the green bars highlighting stocks that appear undervalued and the red bars suggesting stretched valuations
    • We have more detailed and positive views on VSM and TSE as part of our more regular coverage; we are concerned about the smaller cap ammonia/urea producers – so UAN

Exhibit 1

Source: Capital IQ and SSR Analysis

Valuation

In the following sections, we sort our SMID cap universe by Q2 revenue and earnings growth/surprises, as well as volume and price changes where they are reported, and color code for stock attractiveness per the valuation schematic shown below. We use this chart to provide a valuation landscape for the SMID universe, where many of the companies lack sufficient history to generate the normal valuation models that underpin much of our large cap work. Here we are comparing return on tangible capital to an enterprise value multiple of the tangible capital base – stocks above the line of best fit are over-valued relative to peers and returns, and vice versa. Exhibit 2 shows the full universe with outliers labeled and Exhibit 3 offers a closer view of the cluster of companies in the 5-25% ROTC range.

Exhibit 2

Source: Capital IQ and SSR Analysis

Exhibit 3

Source: Capital IQ and SSR Analysis

Volume and Price

Exhibit 4 shows volume and price changes in Q2 for the companies that disclose this information. There are several attractively valued companies sitting in the top right quadrant, showing volume and pricing gains. The trend from Q1 to Q2 is shown in Exhibit 5 – TSE, VSM, and several segments of HUN look most positive; AXTA and GRA Materials most concerning.

Exhibit 4

Source: Capital IQ and SSR Analysis

Exhibit 5

Source: Capital IQ and SSR Analysis

Surprises vs. Consensus

The average revenue surprise in the SMID space was positive again, for the third consecutive quarter, but at a less significant level than in Q1 ’17. Top line beats in the SMID space continue to lag those seen in the large cap arena, suggesting a more robust growth picture internationally relative to the US, where many of these SMID names make the bulk of their revenues. Exhibit 6 shows some individual outliers and Exhibit 7 shows the 15 best and worst revenue surprises. There are plenty of attractive names among the companies with the most significant top line beats – VSM and IIVI stand out. Conversely, there are several expensive screening names with apparently poor sales momentum.

Exhibit 6

Source: Capital IQ and SSR Analysis

Exhibit 7

Source: Capital IQ and SSR Analysis

Year over Year Growth

Exhibit 8

Source: Capital IQ and SSR Analysis

Exhibit 9

Source: Capital IQ and SSR Analysis

©2017, 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.

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