Why Global Brass & Copper Holdings Is A 'Strong Outperform'
GBC looks very undervalued at current prices, especially from a revenue and earnings basis.
Stock price hasn't exactly been on fire recently, but it has solidly outperformed its industry group and the overall market as investors have taken notice of the opportunity.
The 'smart money' is extremely bullish on the stock, with high company insider and institutional buying and low short interest in the stock.
Strong economic and industry tailwinds will continue to buoy the company, especially as the US economy begins to finally heat up.
Following report was written by Quantified Alpha analyst, Joseph Vidi.
In a very competitive industry, Global Brass and Copper (NYSE:BRSS) is certainly not the leader. However, our quantitative analysis along with a qualitative study of their business identifies them as an up and coming player with strong upside potential. Management has been extremely diligent in showing the public that they are working hard to expand the business and become a leader in the distribution of specialty brass and copper. "We believe our strong balance sheet and ability to generate cash flows enables us to continue to invest in our business to support growth and generate strong returns for our shareholders," CEO John Wasz said in their Q4 2014 earnings call. They reported that they faced some challenges in 2014, however their strong results ending the year have put them in a position to capitalize on long-term industry tailwinds.
It is rare that we find such consistent strength in each of the quantitative metrics that we analyze, but BRSS fits every criteria of what we consider a good investment. We'll discuss below how BRSS is an attractive long position with a focus on valuation, growth & momentum, and how the 'smart money' is playing the stock. Each of these breakdowns encompasses well known market anomalies, that allow investors to capture excess returns (see our article on market anomalies for more information).
If you have read one of our articles before, you should know that one of our focuses is to determine a company's value relative to their market value. This is because cheap stocks historically outperform expensive stocks in the long run. The chart below shows our valuation breakdown for BRSS:
The first number is their sales yield, which shows an astronomical 539.43%. This means that for every dollar invested, GBC returns $5.39 in sales, nearly 6.5x its industry group average (83%) and 10x greater than the overall market average (53%). Total sales have been in a slight decline (total 2014 revenue decreased 3% from 2013), but not enough to justify this gross undervaluation.
Earnings yield is also attractive at 10.12%, which is virtually double its competitor's average (5.1%) and 2.5x the overall market's average yield (3.92%). The company is also a free cash flow machine, generating an FCF yield of 27.4% - almost triple the industry group average of 9.33%. The company does look expensive from a book value basis, with a price to book multiple of 12.12 - which is almost four times the industry group average of 2.79. Our valuation model takes a blended approach to valuation, taking a weight of each ratio/metric based on the metric's predictive ability. Overall, our model rates GBC as "Moderately Undervalued." Holding everything else equal, our model projects long-term outperformance from GBC due to its cheap valuation (ex-ante alpha of 6.66%).
C) Growth & Momentum Breakdown
Academic research has shown that stocks with strong price momentum outperform stocks with weak momentum. While this anomaly may not be as strong as the value anomaly, combining the two leads to an even stronger risk-reward than solely using one. As you can see in the table below, the growth breakdown is not as strong for BRSS as its valuation analysis:
Despite being in a very underperforming industry group (-4.31% average 6-month price performance), BRSS has managed to thrive. It has outperformed the market by about 3% over the past 6 months. Since December, BRSS has risen by nearly 30% from its low of $11.50. In the Q4 2014 earnings call, Wasz mentioned that the losses suffered here were caused by BRSS losing one of its key customers back in 2013.
Our philosophy (which is backed by academic research) is that strong price performance and low valuation are the perfect combination. Using both allows you to capitalize on the huge returns of momentum, while limiting downside with a cheap valuation. BRSS has been growing the bottom line, with TTM net income growth of 200%. Another attractive number for BRSS is its return on equity. The initiative shown in management is one of the reasons we are confident in their business decisions. Overall, our model rates GBC as a "Moderate Growth" company, and expects moderate ex-ante alpha (2.93%) because of it.
D) 'Smart Money' Breakdown
The last breakdown we like to use in our analysis is an observation of how the 'smart money' on the street is playing the stock. We consider the 'smart money' to be company insiders, institutions, and short sellers. Each of them brings a different information advantage to the market, and academic research has proven their predictive ability. Similar to our valuation breakdown, the numbers here are very supportive for BRSS. The graph below shows this breakdown:
Insider ownership has increased by 20.5% in the past six months. Evidently, company insiders at the company have become significantly more optimistic, and invested on the company's future success. Trends show that as a whole, sophisticated investors seem to think that machinery industrials are soon to hit their peak in this bull market evidence by the fact that they have begun decreasing their holdings. Insider optimism at BRSS may have rubbed off on comparably large institutions, as recent ownership in institutional holdings at GBC has increased immensely compared to the group, sector and overall market average at +1.86% in ownership over the last few months. Short sellers agree, with an extremely low percentage of the float shorted (1.99%), indicating that shorts don't believe there is much downside in the stock. BRSS' high increases in insider and institutional ownership combined with low short interest portray it as a textbook case of the 'smart money' being unanimously bullish on the stock.
Now that we've broken down the company from a quantitative stand point, we'll look at whether there are any major qualitative trends that favor BRSS.
Below is a graph of how BRSS' sales are allocated by applications, showing that the majority (58%) of their revenue comes from housing, automotive, and industrials.
After a weak recovery from the financial crisis and a weak first quarter in 2015, US GDP growth is projected to be rebound strongly to 2.81% in Q2 2015, and 3.13% in Q3. This same rebound can be seen in the expected uptrend in new home sales, shown below:
This inevitably means that demand for special metals will start to accelerate as the US economy and housing sector continues to heat up. While economist's predictions are notoriously inaccurate, their strong optimism in the US economy is very encouraging. These expectations give us the security of knowing that the potential lag in the market recognizing the tremendous value in BRSS will be buffeted by strong economic tailwinds.
We see tremendous long term upside in Global Brass & Copper Holdings, as the company combines an attractive valuation, strong growth profile, 'smart money' optimism, and industry tailwinds. BRSS releases earnings on Monday, and we expect the company to continue its history of delivering strong results to shareholders. We maintain a "Strong Outperform" on the stock, and it is rated in the 99th percentile of the +3000 stocks we cover. We expect very strong returns from the stock over the next twelve months.