Basic Materials Stocks to Consider Buying
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since it's often hard to predict basic material prices, investors should look carefully at corporate volume and overall industry supply levels. In my view, the best miners are those that are focused on accretive takeover activity while targeting high-grade regions with conservative spending and research-minded exploration. Below, I review three stocks with this perspective in mind.
Hecla Mining (NYSE: HL): A Mixed Bag
Hecla trades at 12.9x forward earnings and has a very clean balance sheet with virtually no debt and a current ratio of 3.5x. The gold & silver producer has an excellent 14.4% return on invested capital, which is more than 650 bps greater than the industry average. Even still, all eight of the reporting analysts rate the stock just a "hold." What explains the tepid outlook?
First, the stock has already risen around 60% from its 51-week low and carries significant risk with a beta of 2.15. But low silver prices have put basic materials investors on the fence. And the company's failed hostile takeover of US Silver makes me worried about how operations will fare on just the organic level. From the Lucky Friday Silver Shaft rock burst incident to EPS underperformance, current operations have been disappointing. The Silver Shift, at this point, however, is essentially rebuilt and ready for production. Lower cash costs at Greens Creek were also largely responsible for the strong operating cash flow of $35 million in the third quarter. Underground drilling results in this region have been, to be sure, stellar with silver grades in two >70 ft. intercepts ranging between 15 and 65 oz/ton.
But the problem, as management has noted, is that "the geometry is so complex and requires substantially more drilling ... we don't know what this drilling will mean to the ultimate tons and grade." San Sebastian development has been delayed, so economic analysis can be performed in the first quarter. All things considered, the company's a "mixed bag."
There are good alternatives to Hecla. Coeur d'Alene trades at only 9.5x forward earnings and is 3% under book value. It also generates a good amount of free cash flow with a yield of 7.8%. Silver Wheaton is also attractive with a PEG ratio of 0.65x and a forecast for 36.6% annual EPS growth over the next five years.
There are several specific reasons to be optimistic on Coeur d'Alene. The company rose 7.1% after BMO Capital upped its recommendation to "outperform" and speculated that Palmarejo's operational setbacks are temporary. Deutsche Bank has an equivalent of an "outperform" rating ("buy") and puts the price target at $50, which is double the current valuation. Management's conservative spending also mitigates risk as it hunts for new resources at San Bartolome. The 5-year EPS growth rate stands at 27.3%, which is well above the 2.2% industry average. If the company can only improve its return on invested capital, which stands at just 5.1%, it would be on its way to substantially creating value.
There are also several specific reasons to be optimistic about Silver Wheaton. It generates a strong 19.6% return on invested capital, which is 1,507 bps greater than the sector average and well above the cost of capital. Put differently, the company is creating value. Assuming Silver Wheaton meets expectations, 2016 EPS will come out to $5.60. At a multiple of 15x, this translates to a future stock value of $84. Discounting backwards by 10% yields a present value of $52.16. This is a ~45% premium to the current market cap and easily warrants an investment. Silver Wheaton is liquid-rich with a current ratio of 14.3x and virtually no debt. Analysts rate it a 1.8 out of 5 where "1" is a "buy." BMO Capital Markets has a $46 price target. At these prices, Silver Wheaton is selling at an irrational discount.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Hecla Mining Company. 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!