Divergence In Steel Multiples And Share Prices Spell Positive Shipping Outlook
~~By Xun Yao Chen, Industrials Analyst

Valuations can often tell investors the outlook of equities in the near future. Although value investors often look for valuations that are low, high valuations can often signal better times ahead. This is especially true for cyclical companies, such as steel producers and shipping companies, as has been mentioned by Peter Lynch in his famous book Beating the Streets.

Steel producers’ valuation rose since April 19th

On May 10th, the EV/EBITDA1 valuation multiple for steel producers in developed Asia2 rose to 9.52 from 8.93 times in April 19th 2013, rising 6.6% based on 2014 EBITDA estimates made by analysts in Asia. The multiple rose over the past few weeks as several central banks initiated interest rate cuts that will generally help support a weak global economy. Talks of the end to austerity in Europe has also fueled the broad market higher. The price index, which represents all steel companies in developed Asia, also rose higher, from 80.97 to 87.13.

High valuation multiples often point to higher earnings in the future. Additionally, analysts as a whole are often extremists with earnings (either extremely bullish or extremely bearish) when fundamentals are starting to deteriorate. For example, EV/EBITDA kept falling from 2007 to 2008, signaling either extreme optimism among equity analysts, which inflates EBITDA, or an increase in the required rate of return demanded by the market, which reduces the amount investors are willing to pay for one dollar of EBITDA — both of which lead to lower valuation multiples. This also happened in 2009 when EV/EBITDA started to rise ahead of an industry turnaround. As long as EV/EBITDA does not begin to fall drastically and the divergence we have seen since mid 2012 holds, it suggests that the market is seeing better earnings than analysts’ estimates.

Courtesy: Market Realist