Metal Products – Procurement and Fabrication Stock Outlook: Prospects Bright – August 29, 2018
The Metal Products – Procurement And Fabrication industry primarily includes metal processing and fabrication services providers. These companies are engaged in the conversion, manufacturing and fabrication of metal into end products. The products are utilized in a variety of applications across a gamut of markets, including construction, mining, aerospace and defense, automotive, oil and gas, electronics/electrical components, industrial equipment and general consumer markets.
These end markets continue to exhibit strength which bodes well for the industry. Business investment is likely to expand in the United States, supported by favorable financial conditions, expanding global markets, lower capital costs and an improving regulatory climate. The recent tax reform is also likely to lead to higher capital spending. However, the recent heightened trade tariffs have left the industry reeling under higher costs of raw material.
The latest industrial production report of the Federal Reserve revealed that aggregate production of fabricated metal products in the United States logged month-over-month growth of 5.9% this July. Also, per the latest Manufacturing ISM Report, fabricated metal products witnessed growth in new orders, employment levels and backlog. This clearly indicates that the Metal Products – Procurement And Fabrication is likely to gain in the months ahead irrespective of tariff-related apprehensions.
Industry Lags in Terms of Shareholder Returns
Looking at shareholders’ return over the past year, it appears that mounting concerns over higher material costs, impact of tariffs, soaring transportation costs, supply constraints have weighed on investors’ confidence in the industry’s growth prospects.
While the stocks in this industry have collectively dropped 12% over the past year, the Zacks S&P 500 Composite and Zacks Industrial Products Sector have rallied 19% and 11%, respectively.
One-Year Price Performance
However, it’s worth noting that there was a significant lack of synchronization in the performance of individual stocks within the group. Some of the Metal Products – Procurement And Fabrication stocks have successfully passed along the increased raw material prices to its customers in the form of price increases or surcharges and thus fared better than the industry.
Industry Stocks Trading Cheaper than Sector
Despite the underperformance of the industry over the past year, the valuation currently looks expensive. One might get a good sense of the industry’s relative valuation by looking at its enterprise value-to EBITDA ratio (EV/EBITDA), which is the most appropriate multiple for valuing Metal Products – Procurement And Fabrication stocks.
Metal Products – Procurement And Fabrication is a capital-intensive industry with high fixed costs, bulk of which is funded through debt. Moreover, the companies have high depreciation expenses due to a large fixed asset base. The EV/EBITDA ratio essentially measures the value of a Metal Products – Procurement And Fabrication company, inclusive of debt and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.
The industry currently has a trailing 12-month EV/EBITDA ratio of 12.6. When compared with its highest level of 14.8 and median level of 10.8 over that period, there is apparently plenty of upside left.
The space looks expensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11. 8 and the median level is 11.5.
Enterprise Value/EBITDA Ratio (TTM)
However, as Metal Products – Procurement And Fabrication stocks have unique characteristics, a comparison of the group’s EV/EBITDA ratio with that of its broader sector is probably the best approach. Such a comparison ensures that the group is trading at a decent discount. The Zacks Industrial Products Sector’s trailing 12-month EV/EBITDA ratio of 14.1 and the median level of 15.1 for the same period are way above the Zacks Metal Products – Procurement And Fabrication Industry’s respective ratios.
Enterprise Value/EBITDA Ratio (TTM)
Outperformance to be Driven by Solid Earnings Outlook
The Metal Products – Procurement And Fabrication industry is expected to continue delivering positive returns over the near term driven by favorable end-market fundamentals, supply chain initiatives and expectations of industry-wide margin improvement owing to strategic initiatives.
But what really matters to investors is whether or not this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry’s prospects for a solid price performance, going forward, is the industry’s earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry clearly shows the market’s evolving bottom-up earnings expectations for the industry and the industry’s aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. There is a clear uptrend in both the year’s consensus estimates.
Price and Consensus: Zacks Metal Products – Procurement And Fabrication Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of the aggregate consensus expectations for 2018.
Current Fiscal Year EPS Estimate Revisions
Please note that the $2.34 ‘EPS’ estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Metal Products – Procurement And Fabrication industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $2.34 ‘per share’ of the industry for 2018, but how this dollar number has evolved recently.
As you can see here, the $2.34 ‘EPS’ estimate for 2018 is up from $2.21 reported at the end of March and $2.09 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Metal Products – Procurement And Fabrication industry have been steadily raising their estimates.
Zacks Industry Rank Indicates Improved Prospects
The Zacks Metal Products – Procurement And Fabrication industry currently carries a Zacks Industry Rank #87, which places it at the top 34% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. In fact, the industry has remained in the top 50% bracket in five of the trailing eight weeks.
Industry Promises Long-Term Growth
The long-term EPS (3-5 years) growth prospects for the industry look appealing when compared with the broader Zacks S&P 500 composite. The group’s mean estimate of long-term EPS growth rate has been increasing since May 2018 to reach the current level of 11.2%. This compares favorably with 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-terms EPS growth could be recovery in the top line that companies in this industry have been showing since the end of 2016.
Another important indication of solid long-term prospect is the improvement in the group’s EBITDA, which is an important metric for evaluating Metal Products – Procurement And Fabrication stocks.
The largest material purchases for the Metal Products – Procurement And Fabrication industry are resins, steel, aluminum and metals and energy (electricity, natural gas and fuel). Lately, higher material costs, primarily related to oil and metal-based commodities have been hurting the industry. Costs have been trending upward during 2018, aggravated further as a result of imposition of tariffs.
Indeed, some players in the industry have been successful in mitigating cost inflation through pricing hikes, resourcing to alternate suppliers to secure better pricing or avoid import and transportation costs. However, these measures take time, and in some case some investment, to implement. Further, it might not be always feasible to pass on higher costs to customers in the form of price increases, given the competitive environment. This in turn could adversely impact revenue and margins of the industry.
Nevertheless, the overall economy and leading economic indicators provide general insight into projecting the industry’s growth. Further, supply chain initiatives, operational cost management and continued focus on driving profitable growth, along with the advancement of strategic initiatives will drive the industry’s growth. A lower tax rate due to the recently passed tax reform will aid margins.
We have one stock from the Metal Products – Procurement And Fabrication industry with a Zacks Rank #1 (Strong Buy) and three other stocks that carry a Zacks Rank #2 (Buy). All these stocks have been witnessing positive earnings estimate revisions.
Price and Consensus: BRSS
Price and Consensus: EAF
Price and Consensus: TKR
Price and Consensus: TRS
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