SSR Industrials & Materials Small-Mid Cap Rankings, July 2015

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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

July 22nd, 2015

SSR Industrials & Materials Small-Mid Cap Rankings, July 2015

  • We update our small-mid cap rankings – the top 20 names are shown in Exhibit 1 along with the change in positioning from last month.
  • There was very little change at the top of the list compared to June – among the top five, TRN and WLK swapped the #1 and 3 spots.
    • We saw modest turnover elsewhere, highlighted by JOY’s entry after a month of 20% underperformance.
  • We parse the universe into small-cap (<$3 billion) and mid-cap ($3-10 billion)the top 10 names in each cohort are shown in Exhibits 2 and 3 on page 2.
    • At the sector level, Exhibit 7 shows the top 3 stocks in each sector for those looking for more sector granularity.
  • The component weightings have been adjusted slightly following a thorough back-test – since 2012 the average 12 month performance of the top 20 stocks in any given month has been 2.3% in excess of the Russell 2000, with nearly identical results (+2.1%) versus the remaining Industrials & Materials stocks in our 150+ small-mid cap universe.
  • The small-mid cap analysis contains many of the screens we use in our broader, larger cap coverage modified slightly for the shorter, noisier data sets in the small cap names.
    • These individual metrics are then combined (using weightings derived from detailed correlation analysis with forward performance) to give a weighted score.
  • We provide these lists as possible fertile ground for those seeking ideas in the small-mid cap Industrials & Materials space.
    • We will continue to refresh this analysis monthly and use it as a screening tool to identify specific names for further research.

Source: Capital IQ, SSR Analysis

Overview

Our framework assesses sectors and stocks on four major dimensions – valuation, return on capital, capital allocation, and earnings estimates and optimism. We use that framework to identify anomalies which warrant further research that can hopefully lead to investible conclusions. In this report, the monthly update of our original work, that thought process is focused on the small and mid cap area. The universe analyzed encompasses 159 names in the Industrials & Materials sector with market caps below $10 billion (though a handful of names have snuck barely above this mark since we began coverage). We note that not all of these companies have full data sets and have necessarily been excluded from some elements of the analysis – we expect to have closer to the full sample size represented in these tables as we continue to refresh them monthly. The ranking methodology has been newly backtested for the past three years – the top 20 ranked stocks in any given month have average 12 month performance 2.3% in excess of the Russell 2000. These results are also consistent if we compare the top 20 names to the remainder of the universe excluding those names. The adjusted weighting is shown in the
Appendix
. Below we have the same analysis as shown in Exhibit 1, but restricted to the small (under $3 billion) and mid ($3-10 billion) cap groups.

Strictly Small Caps (market cap under $3 billion)

Source: Capital IQ, SSR Analysis

Mid Cap Group (market cap $3-10 billion)

Source: Capital IQ, SSR Analysis

Notes on Top Ranked Stocks

In prior months we have highlighted LSTR, GNRC, and the railcar manufacturers in this space. TRN and ARII continue to screen well. There is some concern that we are approaching peak railcar demand, but forecasts call for annual shipments that will exceed 2012 levels in each of the next three years. New US tank car regulation is a boon for ARII which has a proportionally higher tank car exposure versus peers. TRN should benefit as well – our broader thoughts on the fundamentals of that name can be found
here
, but our enthusiasm is tempered by ongoing investigation into the company’s actions relating to its highway guardrail products. These stocks have also experienced a more general fade in tandem with lackluster 1H rail volumes, which have caused several Class I Rails to reevaluate capital spending plans.

Of note this month – Joy Global (JOY) enters both the top 20 overall and the top 10 mid-cap only list. JOY has screened as an inexpensive stock for some time, driven by weakness in the global mining complex. The stock has lost more than 50% of its value over the past year and its relative multiple has not been this low since September 2002. Forward estimates are suggesting a trough stabilization and valuation is approaching historical support levels. The company has $250 million of debt coming due in 2016, but the next maturity ($500 M) is not until 2021.

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, SSR Analysis

Sector Analysis

Exhibit 6 shows the composition of the universe of 159 small-mid cap stocks and Exhibit 7 lists the top three ranking names in each sector, based on the overall analysis in Exhibit 1. The overall composition is not dissimilar to our overall Industrials & Materials universe.

Exhibit 6

Source: Capital IQ, SSR Analysis

Exhibit 7

Source: Capital IQ, SSR Analysis


Appendix

Below we show a graphical representation of our analytical framework. The components are interconnected and include:

  • Valuation
    • The valuation work for our full universe of stocks is heavily based on a company’s long term return on capital. For these small cap names we often have insufficient data histories to utilize our ROC based models, so we here look at EV/EBITDA (forward) and Price/Book.
  • Return on Capital
    • We still consider return on capital but the data set is pulled from Capital IQ on a quarterly basis as opposed to the monthly, model generated, figures that we typically use. Please refer to our piece from January which reviews our methodology and models in greater detail.
  • Optimism & Earnings Revisions
    • We have done extensive work on corporate optimism, finding that companies with management teams that are consistently over-optimistic about their prospects underperform considerably and erode returns on capital in the long term – see our recent piece on the topic.
  • Capital Allocation
    • For the small cap companies here we look at two trailing metrics, 3 year average TSR and dividend yield. We assign a negative weight to the dividend yield, which has a negative correlation with forward performance for this group.

Weighted Score by Company (ranked best to worst):

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. 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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