Materials Sector Analysis l Michael Hughes Stanley The Lorraine Toth Lorraine Toth Overview Overview Market Capitalization: 400 billion Overview Industries Within Sector Industrial metal and mining 44% Forestry and paper 3% Commodity chemicals 38% Specialty chemicals h i l 15% Overview Billion Companies within material sector by market cap 300 250 200 150 150 100 50 ‐ Rio Tinto BHP Billiton Monsanto Potash Corp. Freeport McMoran Vale S.A. Dupont Anglo Dow American Chemical PLC BASF SE Overview SIM Holdings in Material Sector International Paper (IP) 22,500 shares held h h ld Overall return : 18.3% 3.3% of total SIM 3.3% of total SIM asset Overview SIM Portfolio Business Analysis Life Cycle Materials Sector is in the maturity phase life cycle M t i l S t i i th t it h lif l Grow earnings by cutting cost, international expansion or acquisition Profit margin is small across industries C Companies get competitive advantage by being a cost leader i t titi d t b b i tl d Business Analysis Business Condition Cyclical business (movement correlates with S&P C li l b i ( t l t ith S&P 500) 500) Huge international exposure since most companies have operations in several countries Benefit from growth of emerging economies Benefit from growth of emerging economies Business Analysis Supply Condition Businesses’ capital spending increases in general from 2010 B i ’ it l di i i lf 2010 Anticipate increases in demand in the future as economy heals from recession Japan’ss earthquake and tsunami has minimal effect on supply condition Japan earthquake and tsunami has minimal effect on supply condition Business Analysis Demand Condition The economy grows at a sluggish pace; manufacturers haven’t start Th t l ih f t h ’t t t increasing production soft demand for materials Non‐residential construction is still growing at negative rate Demand for durable goods increases rapidly Demand for durable goods increases rapidly Business Analysis Sector Profitability Low Threat of Entry Threat of Entry requires large capital expenditure requires large capital expenditure and incumbent companies possess economies of scale Low threat of suppliers basic materials is needed in the early production process therefore no suppliers or a few early production process, therefore no suppliers or a few suppliers for material companies Moderate threat of buyers currently demand still weak; companies are willing to sell at lower price to increase companies are willing to sell at lower price to increase revenue; undifferentiated products gives buyers more pricing power Moderate threat of rivalry threat of rivalry fragmented industry with fragmented industry with several big players in each industry Low threat of substitute there is no substitute for basic material Economic Analysis Real GDP and Materials Economic Analysis Disposable Income and Materials – 10 years vs. 5 years Economic Analysis Real Capital Spending and Materials Economic Analysis Consumer Price Index and Materials Financial Analysis Beta O Overall Beta (XLB Spdr ll B t (XLB S d Fund) is 1.22 F d) i 1 22 Dividend Yield Continuing to decline – either prices are increasing or dividends are less Continuing to decline either prices are increasing or dividends are less Financial Analysis Revenue Financial Analysis Absolute EPS Financial Analysis Net Profit Margin Financial Analysis EBITDA Per Share Financial Analysis EPS Growth Financial Analysis Return on Equity Valuation Analysis Sector Valuation Materials Sector Absolute Basis P/Trailing E P/Forward E P/B / P/S P/CF Relative to S&P 500 Relative to S&P 500 P/Trailing E P/Forward E P/B P/S P/CF High Low Median Current 8.1 18.8 16.9 10.5 16 12.7 1.3 2.9 2.9 0.5 1.1 1.3 5.4 9.4 9.7 Low Median Current 0.68 1.2 1.2 0.79 1 0.93 06 0.6 1 13 1.3 0.6 0.8 1 0.7 0.9 1 38.6 32 3.7 1.5 12.7 High 1.8 1.9 13 1.3 1.1 1.1 Valuation Analysis Industry Valuation Paper Products Industry Absolute High Low P/Trailing E P/Trailing E 62.4 62 4 P/Forward E 568.2 P/B 2.6 P/S 08 0.8 P/CF 8.9 Relative to S&P 500 Relative to S&P 500 P/Trailing E P/Forward E P/B P/S P/CF High Low 2.8 36.6 0.9 0.5 0.8 Median Current 41 4.1 25 1 25.1 12 2 12.2 8.4 19.8 11 0.3 1.7 1.9 01 0.1 06 0.6 06 0.6 1.7 6.6 5.6 Median Current 0.38 1.5 0.88 0.69 1.2 0.81 0.2 0.6 0.8 0.2 0.4 0.5 0.2 0.6 0.6 Paper Products Valuation P/E multiples well under 10‐year median Good value? Longevity of industry in question in a i increasingly paperless world i l l ld Highly cyclical market IP’s beta is 2.48 Valuation Analysis Industry Valuation Containers Metal/Glass C t i M t l/Gl Absolute P/Trailing E P/Forward E P/B P/S P/CF Relative to S&P 500 P/Trailing E P/Forward E / P/B P/S P/CF High Low Median Current 9.41 15.6 14.8 8 14.6 11.9 1.6 3.6 3 0.5 0.9 0.8 4.2 7.8 7 Low Median Current 0.61 0.88 1.1 0.58 0.88 0.88 0.4 1.4 1.4 0.3 0.6 0.6 0.4 0.7 0.7 22.1 26.5 5.4 1.1 11 High 1.2 1.6 1.8 0.8 1 Containers Valuation Low price multiples across the board Increasing demand in foreign countries Substitute products Tightening commodity prices Products very standardized y Threat of substitute and buyers high Valuation Analysis Industry Valuation Steel Absolute P/Trailing E / g P/Forward E P/B / P/S P/CF Relative to S&P 500 Relative to S&P 500 P/Trailing E P/Forward E P/B P/S P/CF High Low 860.8 826.5 4.5 1.3 35.8 High Low 40.8 34.9 1.7 1 3.3 Median Current 2.8 13.3 29 3.9 12 9.3 0.9 2.2 2.1 0.3 0.6 0.7 2.7 8.1 11.8 Median Current 0.27 0.8 2.1 0.29 0.77 0.68 0.3 0.9 1 0.3 0.5 0.6 0.4 0.7 1.2 Steel Valuation Slow growth since sales hit low in 2009 Emerging countries help demand growth Steel prices still low Aluminum, cement, composites all substitutes Raw materials are highly concentrated Threat of suppliers high P/ Forward E below median Recommendation Hold Outlook for material companies in the near‐term is O tl k f t i l i i th t i negative/market perform SIM portfolio currently underweight material sector by 57 bps Our recommendation from overall analysis is to hold at current position current position