Two Unloved Material Stocks Which Should Be Brought In From the Cold
Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
My value scan is geared towards stocks which fall outside the mainstream of interest, but not necessarily lacking interest from buyers. Since the November lows, stocks attracting the most interest have come from cyclical sectors: Industrials, Discretionary and Financials. However, many of these stocks have driven themselves beyond attractive buy points, which makes building a position difficult. However, out of favor sectors - like Materials and Energy - contain stocks that are off their highs, but not necessarily under heavy influence from sellers. The following stocks should be circled for further analysis.
Alcoa (NYSE: AA) is the world's largest producer of aluminum, yet has a market cap of just $9 billion trading at a share price below $10. According to Trefis, 35% of the company's price estimate is attributed to engineered products, 27% to global rolled products, with the remainder tied to its primary metals and alumina business. But aluminum products and alumina represent more than three quarters of its revenue stream. Not surprisingly, the company operates at the mercy of aluminum prices, prices which have been in a deflationary decline since peaking in 2007. This has had an obvious knock on effect on Alcoa's share price.
However, with cyclical Industrials flying, demand for raw materials should grow. Low cost raw materials have helped fuel profits further up the food chain, despite weak consumer demand. Materials should benefit as cheap supply is consumed (although this will ultimately squeeze Industrials' profits).
Alcoa had a solid Q4, despite weak metal prices. Revenue was up 1% sequentially and up year-on-year, despite a drop in metal prices. Free cash flow is a positive $0.5 billion. Plus the company has the lowest debt levels since 2006 at $7 billion.
Going forward, the company is looking for aerospace to carry weakness in non-residential construction. Aerospace grew 13-14% in 2012 and is expected to offer 9-10% growth in 2013, helped by backlogs for Boeing and Airbus. Demand for aircraft should be fueled by another rise in air travel, and improved airline profitability. However, the sequester will have a negative impact as US defence spending is hit.
Regionally, growth in China and Eastern Europe should alleviate weakness in Western Europe and the United States (the latter to a lesser extent). Last year, the company signed a $7.5 billion deal with China Power Investment Corp for aerospace, electronics and commercial transportation projects. However, the Chinese market is expected to source Alcoa Aluminum for a range of products, from SUV's to beverage cans. The company projects growth of 8 to 10% for China. However, the Chinese Aluminum story may be slowing: in 2010, revenue for Aluminum Corporation of China Limited (NYSE: ACH) grew 78%. In 2011, this growth fell to 26%. And the trailing twelve month figure for 2012 is about par with 2011 revenue. Aluminum Corporation of China sports a negative profit margin and an trailing twelve month earnings loss. If a Chinese aluminum company finds itself struggling, what does it say about Alcoa's prospects?
Alcoa was surprised for the uptick in U.S. Commercial Building and Construction, in addition to a 27% rise in Housing Starts, offering some diversity in the revenue stream. Unfortunately, Western Europe is likely to crimp the Eastern Europe growth story, although a broad European recovery may play a part in a later earnings story.
Overall, the company is looking for 7% growth heading into 2013. CEO, Klaus Kleinfeld, was also bullish on metal prices, stating the fundamentals were "pretty positive and the growth is there" with supply and demand "pretty much in balance", suggesting a solid floor is in place for Alcoa to benefit.
Another player in the Industrial metal space is Stillwater Mining (NYSE: SWC). It operates in the palladium, platinum and platinum group metals, and has some copper and gold exposure too. At the end of February the company released fourth quarter earnings that didn't quite set the world alight, keeping the stock tied to a decline initiated mid-February. However, the company is the largest primary producer of palladium in the world.
Palladium prices have been far more robust than aluminum, recovering strongly from the 2000-02 sell off. The metal trades around $800 an oz, about 30% off its peak price. Palladium has become increasing important for use in catalytic converters. It competes against the once dominant platinum for this space, but as palladium trades at about half the value of platinum, it's a no brainer preference. The use of palladium in catalysts has helped fuel the rally in the metals' price.
Stillwater Mining expects demand for catalysts is expected to increase by 25% over the next 3 years. Given 80% of palladium supply is consumed in catalytic production, the company is looking for demand for the metal to continue. Competition in the provision of palladium comes from Russia and South Africa. Russian supply is falling, and the South Africa situation has labor-related, political and operational issues to consider.
However, the perceived lack of progress by the company has irked large shareholders, and a question on it was quickly rebuffed on the earnings call. The disillusion in the direction the company is heading was helped by lower year-on-year earnings and revenue. A 10.7% drop in metal basket prices and a 15% rise in extraction costs for the same period were blamed, although net income was sharply lower at $55 million compared to $144 million the year before. There was also large cash costs in 2012 which are expected to carry over into 2013. Beyond that, the company didn't offer guidance.
Despite the shareholder troubles, Silverwater Mining appears to have it easy. Other public palladium stocks find themselves in greater trouble. North American Palladium (NYSEMKT: PAL) was a $1 billion market cap stock a couple of years ago, but now finds itself a sub-$0.3 billion company. The company has consistently reported annual losses for the past 5 years, although a net loss of $11.4 million for 2012 is a significant improvement over the $65 million loss reported the year before. The question is whether it can stick around long enough before it's lost in the sub-$1 quagmire of penny-stock-hood.
Platinum Group Metals (NYSEMKT: PLG) is another sub-billion market cap stock flirting with true penny stock status, having already spent part of this year trading below $1 a share. It has mine exposure in South Africa and Canada, which offers some diversity. However, last year it reported its worst earnings in five years with a $10.6 million loss.
The uncertainty inside the Silverwater Mining boardroom may be casting a shadow over the stock, but this is not a reason to think a directorship shuffle would necessarily be bad for the company. The company has an apparent lock on the North American PMG market, with competitors heading towards situations when they may need to divest their assets. The question is whether the existing executive is capable of maximizing the situation for Silverwater Mining's benefit.
Declan Fallon has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
