The basic materials sector has been in the dog house for the first quarter of 2013, yet has been on a tear over the last week. The gloomy global growth outlook perpetrated by Europe, China and the U.S. wreaked havoc on many basic materials stocks. Nevertheless, conjecture regarding China's inflation rate being under control sparked a rally in the sector this week. See chart below of top 20 basic materials stocks all in the green.
See chart below of the Materials Select Sector SPDR (NYSEARCA:XLB) provided by Yahoo.com. The golden cross was just achieved where the 50-day sma passes above the 200-day sma. This is a bullish event for the sector.
The major catalyst for the sector is China's improving growth prospects. Alcoa (NYSE:AA) stated on its recent earnings conference call that the outlook for Chinese growth was 8 to 10%. You can read the transcript here.
I posit this news coupled with the quantitative easing and stimulus actions taken by the Fed, ECB and many other central banks around the globe will underpin the basic materials sector. I have selected five stocks to review with significant upside from current levels.
In the following sections, we will perform a review of the fundamental and technical state of each company as well as any catalyst for growth. The following table depicts summary statistics and Tuesday's performance for the stocks. The following charts are provided by Finviz.com.
Alpha Natural Resources, Inc. (ANR)
ANR is trading 54% below its 52-week high and has 41% upside potential based on the consensus mean target price of $11.16 for the company. ANR was trading Tuesday for $7.90, up almost 5% for the day.
Fundamentally, ANR has some positives. EPS for the next year is expected to rise by 38.60%. ANR is trading for approximately a 65% discount to book value. On the negative side, the company has a net profit margin of -41%; a negative ROE of -39.49%. Yet, EPS is improving substantially quarter over quarter.
Technically, ANR looks weak. The company has been in a solid downtrend since the beginning of the year. The recent rally is still an unproven trend.
The risk/reward ratio seems favorable at this point. The company is down over thirteen fold from its 2008 high of $100. Alpha recently reported narrowed losses and posted much better earnings than were expected. The company is doing a great job of cutting costs and rightsizing production based on the current demand. I like it here.
Peabody Energy Corp. (BTU)
Peabody is trading 33% below its 52-week high and has 48% upside potential based on the consensus mean target price of $31.15 for the company. Peabody was trading Tuesday for $21.01, up over 3% for the day.
Fundamentally, Peabody has some positives. Peabody is trading for 13 times free cash flow and 15% over book value. EPS for the next year is expected to rise substantially. The company pays a dividend with a yield of 1.62%.
Technically, the stock has been in a downtrend for the past few months. The stock just broke above the first level of resistance at the 20-day sma.
The company is down almost four-fold from its 2008 high of $82. The recent rise in natural gas prices bodes well for the coal sector. If global growth picks up like most are expecting, the stock should do well. The risk/reward seems favorable here.
Cliffs Natural Resources Inc. (CLF)
The company is trading 70% below its 52-week high and has 43% upside potential based on the consensus mean target price of $49.19 for the company. Cliffs was trading Tuesday for $20.45, up almost 9% for the day.
Fundamentally, Cliffs has several positives. Cliffs pays a dividend with a yield of 2.93%. The company has a forward P/E of 8.56. Cliffs is trading for a 37% discount to book value. EPS is expected to be up over 37% next year.
Technically, Cliffs is in a long-term downtrend yet recently spiked higher on the China news. The stock is trading just 15% off its 52 week low.
Cliffs has been beaten down severely in recent weeks. With the change of the quarter, it seems a rotation into the beaten down materials sector has begun. This bodes well for Cliffs as it is one of the most beaten down of the major basic materials players. The risk/reward at this level seems favorable. I like the stock here.
Freeport-McMoRan Copper & Gold Inc. (FCX)
The company is trading 21% below its 52-week high and has 19% upside potential based on the consensus mean target price of $40.07 for the company. Freeport was trading Tuesday for $33.76, up over 4% for the day.
Fundamentally, Freeport has several positives. Freeport pays a dividend yielding 3.70%. The company has a forward P/E of 7.15. Freeport is trading for slightly less than two times book value. EPS next year is expected to rise by 10% and up 15% quarter over quarter. The company has a net profit margin of 22.08% and an ROE of 18%.
Technically, Freeport was in a well-defined downtrend from October of last year. When the company announced a couple of major acquisitions in December, the stock dropped like a rock to $30 and has been slowly climbing higher since.
I feel the backlash by Freeport's shareholders over the $20 billion buyout deals was overdone. The stock is a buying opportunity here after bouncing off support at $30. This is an ideal time to start a long-term position in Freeport.
United States Steel Corp. (X)
The company is trading 39% below its 52-week high and has 47% potential upside based on the analysts' consensus mean target price of $26.41 for the company. US Steel was trading Tuesday for $17.99, up over 4% for the day.
Fundamentally, US Steel has some positives. The company has a forward P/E of 8.25. EPS is up 76% quarter over quarter. US Steel is trading for 75% of book value. EPS next year is expected to rise by 144%. The company pays a dividend of around 1%.
Technically, the stock has been in a well-defined uptrend for several months until it began to fall apart as of late. The stock is still trading significantly lower than all three major moving averages.
The last time US Steel was trading at this level it had a nice run up to $26. I believe the entire sector has been oversold and is due for a bounce. The span of the rally is telling. I see this as a chance to get into the stock before things start to really turn around.
The Bottom Line
A vast sell-off of the basic materials sector based on unprecedented macroeconomic and geopolitical global growth anxieties has occurred over the last few months. This has created some tremendous buying opportunities in the space. A rally has begun this week, yet there is still a tremendous amount of potential upside. I posit the stocks covered in this article have not completely priced in the change in China's growth prospects. These stocks still have much more room to run.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BTU, ANR, FCX, X, CLF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment.