2 Stocks to Buy, 1 To Sell
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While some have speculated that there will be a double dip, others have argued that that is extremely unlikely. In my view, economic progress indicates stronger support for the latter camp - one that includes the opinion of Federal Reserve Chairman Ben Bernanke. In any event, economic growth has been sluggish and there could be increased pressure on politicians to take inflationary measures to boost aggregate demand. This means strong returns for gold producers.
All in all, however, the macro landscape is highly uncertain. Basic materials are largely discounted across the board, and will, in my view, either generate significant outperformance if the macro bulls are right or significant underperformance if the macro bears are wrong. I recommend buying shares in Alcoa (NYSE: AA) and Barrick (NYSE: ABX) while holding out on US Steel (NYSE: X). Here's why:
Alcoa has been unreasonably beaten down. Shares have fallen by nearly a third over the last 52 weeks and are near the period's low. The company now trades at just 0.55x book value versus the 1x historical 5-year average. If Alcoa can end up growing EPS by 11.6% annually as expected, it is well positioned to expanding multiples at least to historical levels.
At first glance, it is easy to see why the bears are so optimistic that they have found their next target. EPS over the TTM (trailing twelve months) has fallen dramatically since 3Q11. Still, the company performed in-line with expectations in 2Q12 and had a stellar EPS return of $0.10 in 1Q12 versus the loss of $0.04 that was expected. Moreover, EPS over TTM has steadily recovered from 3Q09 lows.
Much of the reason for the low stock price is poor aluminum prices. Alcoa is well extended in its markets and particularly vulnerable to economic swings. Fundamentals, however, prevail in the long-term, so investors are myopically focusing too much on the unpredictable. Multiples are likely to elevate, so this roller coaster ride of short-term uncertainty appears to be heading nowhere but up.
Ditto for Barrick, which trades at 8.3x past earnings and 6.8x forward earnings. Better yet, the PEG ratio is at 0.3, which indicates that future growth has been nowhere close to being fully factored into the stock price. Analysts expect the firm to grow EPS by 27.8% annually over the next 5 years. That implies huge returns even at huge discount rates.
During the 2Q, the company produced $0.78 in EPS, which was 18.8% below consensus. Even still, the stock decline of 24.6% for the year to date appears to be overblown given that most peers outperformed. Barrick has a strong economic moat and top management in its field. Reduced expectations for Pascua-Lama have been a bit of a wet blanket for the bulls, but there are still tailwinds to the upside. The announcement of a quarterly dividend at a high starting yield of 2.3% demonstrates management's confidence over long-term free cash flow. Production is kicking in at Pueblo Viejo and the business is moving towards operations that will allow for higher margins.
US Steel has negative ROA, ROE, and ROI with a low 0.9% dividend yield. The price-to-book ratio, 0.9x, is also not very compelling against cheaper peers. Moreover, the wind is not in the stock's favor as the consensus rating is currently closer to a "sell" than a "buy,' according to data sourced from FINVIZ.com.
My biggest concern with US Steel relates to their overall business model. Manufacturing is cheaper abroad and, perhaps more importantly, there is less pressure from labor unions abroad too. Pension liabilities represent a major cliff for value creation with the most recent 10-K disclosing that it was short $2.4 billion on pension plans. Then there was the disclosure that it was short $2.7 billion in some insurance plans. Despite the poor shortfall, the company has pointed towards a 7.8% annual return on those assets. Should this high bar not be met, shareholders are likely in for even more downside.
Iron & steel is also a very competitive industry - and with losses and burdensome debt racked up, US Steel may not be able to optimally move towards volatility. This warrants holding out until greater visibility emerges.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.