By identifying potential change candidates and adopting different routes such as consolidation from M&A, one can spot low returns industries which can repair themselves, notes Goldman Sachs.
Hugo Scott-Gall and Sumana Manohar of Goldman Sachs in their report dated July 1, 2014 titled: “The value in repair” provide pointers for low-return industries that are improving at the margin and where that might not be in the price.
Low returns industries: The value in repair
The Goldman Sachs analysts note low returns industries can repair themselves. The analysts suggest various tools to identify such candidates. For instance, one can have a closer look at potential change candidates such as steel, paper and packaging, airlines, big oil and Japanese oil refining and Asian PC assemblers. Moreover, the analysts also suggest four different routes to identify such candidates such as consolidation from M&A, capital discipline by existing players facilitating higher cash generation and equity rebuild, new sources of growth that transform the industry’s prospects and industry reinvention where new business models emerge.
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The Goldman Sachs analysts highlight buy-rates stocks from their European coverage that satisfy three value metrics viz.: Price/10 year average earnings less than 1.6x, trailing earnings yield over 2 times current AAA corporate bond yield and dividend yield above two-thirds of current AAA corporate bond yield.
The following table captures the analysts’ three value metrics:
The Goldman Sachs analysts have also come out with the following list of companies which show good upside potential:
Low Vs High multiples
The Goldman Sachs analysts note stocks on low multiples have outperformed those on relatively high multiples, as captured in the following graph:
Citing an example for new sources of growth that transform industry’s prospects, the analysts point out that tougher emissions regulation is pushing auto manufacturers to make lighter cars resulting in a new demand opportunity for aluminum sheet. The analysts elucidate how autos are repairing nicely through the following chart:
Armed with the following chart, the Goldman Sachs analysts elucidate % of stocks by sector in their European coverage and coverage that screens as value:
The Goldman Sachs analysts conclude that there is opportunity even in bad industries becoming less bad and hence there is value in repair.