Basic Material Stock Roundup: The Good & The Bad
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Many long-term stock traders encourage investors to "keep things simple." If you are interested in buying basic material stocks, you can accomplish this strategy by investing in diversified producers. Freeport, BHP Billiton, and Vale are engaged in everything from basic metals to oil & gas, copper, and even rail transportation. Below, I review the latest events of each firm and provide my views on how they bode for shareholders.
The Pros & Cons To A Freeport (NYSE: FCX) Investment
Freeport is a global miner that focuses primarily on the copper and gold production. In addition to domestic mining, it has exposure to Indonesia through its Grasberg operations, the Democratic Republic of Congo through its Tenke operations, Spain through its copper smelting operations, Africa, and South America. 10 of 14 reporting analysts rate the stock a "buy" or better--8 of which say "hold." No analyst recommends selling the stock.
There are several reasons to share this optimism. First, the miner generates a strong return on invested capital of 14.2%--well above the historical 5-year average of less than 5%. At 10.4x past earnings, the company is also within range of its historical 5-year average PE multiple (10.8x) and 10% below the peer average. When you factor in a 3.9% dividend yield, risk/reward appears good.
However, shares have rightfully lost nearly a third of their value from the 52-week high after Freeport bizarrely decided to gain exposure to the oil & gas industry. In just two days of announcing the oil deals, it plummeted $7.1 billion--more than the price ($6.9 billion) it paid for Plains Exploration. Moody's, however, has kept the firm three places above junk with a Baa3 rating. The agency argues that Freeport's capacity can meet the added interest expenses, while Plains helps drive cash flow. One could even argue that Freeport's strong balance sheet will drive incremental deep water growth for the target. I still tend to agree with Jim Cramer that the deal "doesn't pass the smell test" and will have the effect of convincing shareholders that the copper business is fundamentally weak. It basically signals to the market how hard it is to find new copper projects in politically stable areas.
In the near-term, Freeport is expect to see an EPS growth rate of just 4.7%. When you factor in dividend yields, this means a total annual return of 8.6%. This is not an ideal return for an active investment, since it doesn't beat the average market return.
BHP Billiton is an even more diversified miner with exposure to petroleum, aluminum, steel, iron ore, coal, base metals--you name it. Vale is engaged in iron ore, cargo transportation through rail and shipping, and fertilizers. BHP trades at 16.4x forward earnings but is rated very favorably on the Street with a rating of 1.9 out of 5 where "1" is a "buy." Vale is even cheaper at 7.8x forward, but is only rated a 2.5. What explains the pessimism?
Vale has lost nearly 20% of its value in the last 12 months. China has banned heavy-cargo carrying Valemax ships, which resulted in the company losing upwards of $3 per metric ton in iron ore shipping costs just from transferring the ore into smaller ships. In addition, the Valemax ships were saving $6 per metric ton. And while some analysts have applauded the decision to trim both capex and R&D, I believe it showcases a negative outlook that reflects management's expectation for slow growth. Business is more unpredictable than ever with more shipments going towards China and Japan. On the other hand, the new license to expand the Carajas railroad represents a catalyst in connecting the company to the world's largest iron ore mine. And, further, the company expects to increase the number of projects and increase market share, as it increases output by upwards of 25 million metric tons per year over the next 5 years.
BHP still has a bright future going forward. Alcoa has already expressed interests in buying the firm's aluminum assets under the expectations of 6.5% demand growth per year. The company has already sold its diamonds business to Harry Winston for $500 million, which was the right decision because the company was failing to increase scale fast enough. At the same time, the company will be endeavoring to cut costs to offset the decline in iron ore prices. And with a great exposure to US shale gas, which has been cited by energy billionaire T. Boone Pickens as the industry's catalyst, the company can capitalize off its strong connection to Asia. Japanese utilities have shown greater interest in shale gas, so shipping to this high-growth market is ideal now.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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!