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.
Four years high valuation ratio for steel producers suggests better times ahead
On January 25th, 2013, the EV/EBITDA valuation multiple for steel producers in developed Asia, which accounts for Korea, Japan, Singapore, Taiwan and Hong Kong, rose to a high of 8.19 based on Bloomberg Industry data. That is higher than what we have seen back in early 2009 when equity values also rose ahead of improving fundamentals.The valuation multiple jumped in December from ~7x to ~8x driven in part by Japan’s push towards devaluation of the yen and the possible announcement of a stimulus package to prop Japan out of a recession, led by the new prime minister Abe Shinzo. As of January 25th, 2013, the price index for the selected steel producers stood at $86.39.
A rise in Japan’s demand for steel will benefit dry bulk shipping
An increase in Japan’s demand for steel is favorable for the shipping industry as the country is the second largest importer of iron ore behind China and the biggest for metallurgical coal. Rising trade volume should add revenue to dry bulk shipping companies (companies that ship dry raw materials such as iron ore and coal across oceans) such as DryShips, Inc. (DRYS), Diana Shipping, Inc. (DSX), Eagle Bulk Shipping, Inc. (EGLE) and Excel Maritime Carriers, Ltd. (EXL). As some companies may be in distress, investors may consider the Guggenheim Shipping ETF (SEA), which invests in leading shipping companies worldwide and corresponds generally to the Dow Jones Global Shipping Index.