SSR Industrials & Materials Monthly Review, August 2017: Very Mixed Performance Behind Equally Mixed Macro

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Graham Copley / Nick Lipinski



September 1st, 2017

SSR Industrials & Materials Monthly Review, August 2017:

Very Mixed Performance Behind Equally Mixed Macro

  • A mixed month of performance at both the sector and subsector level
    • Wide variation in performance favored Transports and E&C in aggregate while machinery sectors underperformed
    • Top individual performers came from the Metals space – AA +20% as China curtailments boosted aluminum pricing and outlook
  • US economic indicators are sending somewhat divergent messages, but importantly, consumer sentiment appears to be undaunted by political headlines or natural disasters
    • Construction and consumer spending have been trending in opposite directions – surprising slowdown in construction, continued steady gains in consumer as the job market remains resilient
    • History suggests the economic impact of major storms is subdued but we are already seeing the start of the certain noise to follow in the energy and chemical markets
  • Over the past month we have published work on:
    • Coatings – we removed PPG from our favorites list and see problems for the industry in general with slowing underlying fundamentals in the near term and the potential for disruption in the long term
    • The SMID cap space – scanning a group of ~120 stocks, Q2 results revealed several cheap stocks with apparent momentum and several more fully valued stocks facing apparent challenges – VSM and TSE among our favorites here
    • Industrial Gas:
      • Linde/Praxair – our preferred play in the space has considerable upside based on a detailed pro-forma model
      • Air Products – likely to be the laggard moving forward as it gets squeezed out of capital spending opportunities by larger competitors
      • Air Liquide – less negatively impacted than APD by the Linde/Praxair deal, the US (Airgas) expansion story should provide the stock with a growth runway – upside to the stock depends on the company’s level of cost focus
    • Paper & Packaging – containerboard is a relatively undervalued area of focus within the space – IP appears to have the most upside
  • Exhibit 1 summarizes our preferences by sector and stock
    • Mega mergers offer the most potential upside in Materials – see PX/LIN comments above – we remain bullish on DOW/DD
    • In Industrials, with GE off our favorites list, we are most positive on SWK in the large cap space

Exhibit 1

Exhibit 2

Source: SSR Analysis – Normal Value looks at valuation relative to historical norms and the SI measures current valuation versus current return on capital and what movement in returns on capital is implied in valuation.

Exhibit 3

Source: Company Reports and SSR Analysis

See Appendix 3 for the data underlying this exhibit.

Exhibit 4


Aside from construction spending, most of the indicators in Exhibit 5 below are trending in the right direction, but perhaps the most important takeaway is that the US consumer appears undaunted by political gridlock or natural disasters. Consumer spend, with its roughly 70% contribution to US GDP, appears to be poised for continued strength in the back end of 2017 as confidence/comfort indices are at or approaching multi-year highs. Manufacturing readings also remain healthy and the only real areas of concern for the US economy are likely past-peak auto sales and a discouraging trend to construction spending. There may not be any easy fixes here, given the increasingly stretched nature of the auto loan market and the government’s disproportionate influence on the construction spend declines. The political agenda has moved to tax reform, which could provide an offsetting boost to share prices. Globally, the rise in copper pricing – Exhibit 6 – suggests strong demand for the bellwether metal and a healthy economic landscape. As it stands, August was a mixed month for Industrials & Materials stocks, with a wide variation of performance both at the sector and subsector level. AA rode the surging aluminum pricing shown in Exhibit 6 to a 20% monthly gain, best in the universe, and X was right behind it (+13%) on internal investment efforts – these two account for only 12% of the cap weight in our Metals group, which overall underperformed as the rally in pricing did not extend to steel and both NUE and STLD lagged. There were several hurricane related moves higher, notably storm-dependent Generac (GNRC); WLK and OLN were outperformers in the Chemical space and top 10 monthly gainers within our universe; and the trucking companies rebounded from largely disappointing earnings as cleanup efforts are expected to constrain available capacity. Sector performance for the month of August is shown in Exhibit 7. We show the 25 best and worst performing stocks in Appendix 1.

Exhibit 5

Source: Bloomberg, ISM, US Census Bureau, BEA, and SSR Analysis

Exhibit 6

Source: Capital IQ and SSR Analysis

Exhibit 7

Source: Capital IQ and SSR Analysis

Exhibit 8 summarizes discount from normal value by sector. GE’s underperformance continues to drive the valuation divergence between the Conglomerates inclusive and exclusive of the mega cap.

Exhibit 8

Source: Capital IQ and SSR Analysis

Values for our Skepticism Index are summarized by sector in Exhibit 9 (see our skepticism work for more detail). Valuations and returns are in-line for several sectors (SI close to 0) and the only relative extreme value continues to be in Metals.

Exhibit 9

Source: Capital IQ and SSR Analysis

Exhibit 10 is a very busy chart but shows how each sector and sub-sector breaks down by skepticism index component – valuation versus ROC. We continue to see a broad range of valuations despite returns that are mostly within half a standard deviation of trend. Coatings remains the prominent outlier – SHW’s runaway return on capital is influencing the group but PPG’s returns are also near an all-time peak above trend.

Exhibit 10

Source: Capital IQ and SSR Analysis

Portfolio Performance

Every month we take the top and bottom 25 stocks on our normal valuation and skepticism index frameworks (summarized in Exhibit 2) and track the results, which have typically been robust, particularly for the overlap of the two. 2016 was a strong rebound year for this portfolio selection methodology after 2015 failed to live up to the record established in 2013 and 2014 – Exhibit 11. Results in 2017 to date have been roughly flat for the overlap selections, slightly negative for the SI selections, and +4% for the normal value selections.

Exhibit 11

Source: Capital IQ and SSR Analysis

An alternative portfolio approach is based on our expanded skepticism index performance analysis which showed a very attractive risk-reward relationship for stocks with positive SI values, valuation discounts, and positive 3 month EPS revisions. This month we have 27 stocks that currently fall in these historically outperforming ranges, one fewer than last month – Exhibit 12.

Exhibit 12

Source: Capital IQ and SSR Analysis

Exhibit 13 shows the historical forward performance of the stocks meeting the criteria in Exhibit 12 at various ranges. We note that for all ranges where the SI is above 0.5, the average return is in excess of the variability (average > standard deviation).

Exhibit 13

Source: Capital IQ and SSR Analysis

Macro Environment

At SSR we are not economists, nor do we seek to be. We look at the economic indicators that are publicly available and put them into context relative to the drivers within the industries we cover. We examine trends or fundamental influences and we then look at these relative to valuation with the goal of identifying mismatches between what is implied in valuation and what is expected to happen.

History suggests that the emotional aftereffects of major natural disasters such as Hurricane Harvey are likely to outweigh any impact on GDP, though we are already seeing the start of the certain noise to follow in the energy and chemical markets. US second quarter GDP was revised up to 3% and consumer sentiment indices provide optimism that the momentum can continue in the second half of the year – that sentiment indices have risen in the face of the misfortune in Texas and a seemingly endless barrage of negative political news is telling for the health of the US consumer economy. With the governing party badly in need of a win, the political agenda has shifted to tax reform, which could provide a boost. The global economy appears to healthy and growing steadily as indicated by doctor copper – pricing gains imply strong demand for the bellwether metal. Reports of a spat on the Chinese-Indian border ruffled some feathers but escalation is seen as far less likely than in North Korea, where the saber rattling continues. China’s commitment to curtailing certain industrial capacities is becoming evident, notably in aluminum pricing. India meanwhile continues to grapple with the fallout from its large denomination cash ban. We are beginning to see signs of inflation in the Euro’s core (notably Germany) which could impact the ECB’s stimulus policy as the group convenes in early September.

Exhibit 14

Source: Capital IQ, Government Publications, Bloomberg, SSR Analysis

Commodity Pricing

US commodity and energy prices are indexed in Exhibits 15 through 19. Improvements in pricing for aluminum and copper reflect supply curtailments in China and a generally improving global economy respectively – Exhibit 6. The aluminum price change drove AA to a 20% gain on the month, the largest in our universe. Monthly and year to date pricing gains have not extended to steel – X saw significant gains more on internal restructuring than external fundamentals.

Exhibit 15                                                                           Exhibit 16

Source: Capital IQ, IHS, CRU Steel Price Index, Bloomberg, SSR Analysis

Exhibit 17

Source: Capital IQ, Bloomberg, SSR Analysis

Exhibit 18                                                                             Exhibit 19

Source: Capital IQ, IHS, Bloomberg, SSR Analysis

Expectation Analysis

In Exhibit 20 we look at expected net income growth by sector, and in Exhibit 21 we plot the growth figure against each sector’s current skepticism index value.

Exhibit 20                                                                                 Exhibit 21

Source: Capital IQ and SSR Analysis

Exhibit 22

Source: Capital IQ and SSR Analysis

Exhibit 23 shows average 2017 EPS revision over the past month and Exhibit 24 plots these revisions versus performance results on the month. Note these revision figures are a simple average versus the cap weighted revisions shown in Exhibit 4.

Exhibit 23                                                                                 Exhibit 24

Source: Capital IQ and SSR Analysis Source: Capital IQ and SSR Analysis

Mid-Cycle “Normal” Valuation

In Exhibits 25-34 on the following pages we show the historical current discount/premium to normal mid-cycle value by sector.

Exhibit 25

Source: Capital IQ and SSR Analysis

Exhibit 26

Source: Capital IQ and SSR Analysis

Exhibit 27

Source: Capital IQ and SSR Analysis

Exhibit 28

Source: Capital IQ and SSR Analysis

Exhibit 29

Source: Capital IQ and SSR Analysis

Exhibit 30

Source: Capital IQ and SSR Analysis

Exhibit 31

Source: Capital IQ and SSR Analysis

Exhibit 32

Source: Capital IQ and SSR Analysis

Exhibit 33

Source: Capital IQ and SSR Analysis

Exhibit 34

Source: Capital IQ and SSR Analysis


Our Skepticism Analysis by sector is summarized in the Exhibits 35 through 45.

Exhibit 35

Source: Capital IQ and SSR Analysis

Exhibit 36

Source: Capital IQ and SSR Analysis

Exhibit 37

Source: Capital IQ and SSR Analysis

Exhibit 38

Source: Capital IQ and SSR Analysis

Exhibit 39

Source: Capital IQ and SSR Analysis

Exhibit 40

Source: Capital IQ and SSR Analysis

Exhibit 41

Source: Capital IQ and SSR Analysis

Exhibit 42

Source: Capital IQ and SSR Analysis

Exhibit 43

Source: Capital IQ and SSR Analysis

Exhibit 44

Source: Capital IQ and SSR Analysis

Exhibit 45

Source: Capital IQ and SSR Analysis

Research Published in August
August 21, 2017: Coatings – Heading for Bad Patch – Hard to Identify Winners

August 18, 2017: SMID Cap I&M – Some Still Cheap Stocks with Momentum and Some Expensive Laggards

August 16, 2017: Chemicals August – Earnings Up, Stocks Down

August 10, 2017: Air Liquide – Good or Great Will Depend on Approach to Costs

August 9, 2017: Paper and Containerboard Stocks: Still Cheap, Despite A Good Start

August 8, 2017: Air Products – Needs To Find A Very Big Rabbit In A Very Small Hat

August 7, 2017: Linde/Praxair – The Size Of The Prize Is Substantial


In Exhibit 46 we show a screen of stocks with low value, high skepticism and high dividend yield. EMN falls just outside the top 25 dividend yields, and UPS has fallen out of the valuation screen after a strong month, leaving holdover OLN as the only stock to appear on all three metrics.

Exhibit 46

Source: Capital IQ and SSR Analysis


Appendix 1

Appendix 2

Appendix 3

Appendix 3

©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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