After Crashing, Consider Buying These 2 High-Risk Metal Miners
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The last six months have been a rough period for metal miners: Cliffs Natural Resources (NYSE: CLF) and BHP Billiton (NYSE: BHP) are down 43.3% and 16.5%, respectively, while the S&P 500 is up 5.3%. All three of these producers now trade at very low multiples and, what's more, they are still forecasted for fairly good growth. Analysts expect Cliffs to grow EPS 16.8% annually over the next half decade versus 10.7% for BHP Billiton and 16.8% for Rio Tinto. Both of these stocks are nevertheless high risk, so I recommend spreading your holdings across more basic material producers (particularly those in gold). Below, I review the fundamentals of each firm.
Cliffs Natural Resources
Steel and iron producer Cliffs has floundered but now trades at just a respective 3.5x and 4.4x past and forward earnings. According to data sourced from FINVIZ.com, it offers a dividend yield of 6.3% and is rated closer to a "buy" than a "sell" with a $70.56 price target. While FBR Capital recently downgraded their price target from $102 to $56, they are still expecting upside relative to the current stock price. It isn't just analysts that find the stock undervalued... According to Insider Monkey, Cliffs has a fund that has $105 million invested in the company.
During the second quarter earnings call, the company released disappointing results with adjusted diluted EPS of $1.46 - well below the $1.77 consensus. Coal volumes fell 2% while SG&A was up 11%. North American coal was a dismal $15 million - indicative not of just seasonal weakness, but fundamental, structural, and macro weakness. Management nevertheless anticipates stability during the second half of this year with Chinese steel production reaching 730M tons, and they did not lower US iron ore guidance. They did, however, lower their guidance for Canadian iron ore sales by 20% while upping cost estimates. On both fronts - costs and volume - the near future is not looking the brightest. The question then turns to how much this will be the case in the long-term and whether investors betted down the stock too much.
BHP Billiton
Trading at just 7.8x past earnings, BHP similarly appears cheap on a multiples basis. More importantly, the PEG ratio stands at 0.73, which indicates future growth projections have not been fully factored into the stock price. Analysts forecast 10.7% annual EPS growth over the next 5 years, which translate to a future stock value of $110.37. Discounting backwards by 10% yields a present value roughly in-line with the current market assessment. Thus, BHP should be classified more as a high-risk growth investment than contrarian value play.
Several factors are limiting BHP's value story. First, investors are afraid of slowing Chinese growth. Second, investors are afraid of the debt crisis. Combined with the FX headwind, altogether too many investors are viewing BHP as being in a "perfect storm". The company's correlation with commodities has become less meaningful of late, which is resulting in many feeling as though there won't be any USD cost relief during the downturn as the AUD strengthens. Sentiments are at an all time low since the financial crisis. This is largely due to the fundamental shift from price-makers to price-takers.
In my view, these risks are offset by stable cash flow and margins. Exposure to petroleum is particularly helpful in keeping up margins since capex is typically allocated upfront. The firm also has the largest set of low-cost mines that can be easily expanded. During the June quarter, management yielded solid iron ore volumes at 40.7M tones, which was the 12 consecutive that BHP yielded record annual production.When it comes to diversification, BHP also is a leader among peers. In addition, BHP has been able to retain greater pricing power than peers due to its focus on takeover activity. With the wherewithal to survive volatile commodity markets, BHP will live to ride the positive secular trends from a rising consumer population in China and India. Accordingly, I recommend investors make a small speculative stake.
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