In terms of its market-cap weighting, Basic Materials is just 3% of the S&P 500, and never really in the discussion with technology and financials as major sectors of the S&P 500. The sector had a brief blaze of glory in the last decade when China was growing 15% a year and the commodity complex was on fire, but once again, a number of these stocks are now oversold on the weekly and monthly charts as the sector awaits a return to global growth.
From what i understand Chemicals is 75% - 80% of the sector, with the rest being the mining/smelting companies, etc.
Here is a quick summary of their recent earnings, and what we see going forward:
Every time I look in a client account and see this stock, I want to punch myself in the face repeatedly, as hard as i can, but like Seinfeld's George Constanza, I also know that when I get like this regarding a particular holding, It is best to do the opposite of my instincts and wait a little longer.
Alcoa just announced Wednesday, May 1, that they were considering curtailing another 460,000 metric tons of smelting capacity as Moody's changed the outlook on Alcoa's credit rating from stable to negative. Alcoa has to do something here. One rumor was that they might divest the hot-rolled metals segment of the business. (Can't confirm that.)
Earnings and revenue estimates are still being reduced, even in the last 30 days since Q1 '13 earnings were reported: after the April 9th report, the 2013 and 2014 EPS estimates were $0.47 and $0.78 per share, but just since mid-April those estimates are now $0.44 and $0.73.
Technically, the stock has held $8 and hasn't made new lows despite the news of shuttering further capacity. AA is as oversold on the monthly chart as it was near the 2008 - 2009 lows.
The credit rating was watchlisted given the dwindling free-cash-flow. Something has to give. Look for some kind of M&A activity around AA. Our model values AA at $10 - $11, Morningstar thinks AA's fair value is $19. At $8.50 per share, AA is trading at a 15% discount to tangible book value (TBV) of $9.97.
Klaus Kleinfeld's (Alcoa's CEO) happy talk is getting old.
Freeport Copper (FCX):
The $20 billion PXP merger is set to close as early as May 20th, and no later than the end of the 2nd quarter. The widely-disparaged acquisition of PXP by FCX might be now be seen as dumb as a fox, given the slide in the price of copper, and oil and gas look to be a better bet on the future. Still, the PXP merger is expected to strain cash-flow until 2015, and limit any dividend and share repurchases given how the deal was financed.
For FCX, the price of copper averaged $3.51 in q1 '13 versus $3.82 in q1 '12.
The dividend yield is 4.5% currently and won't likely increase much over the next few years. Our internal model and Morningstar puts an intrinsic value on FCX in the mid $30's. The stock recently held its 2010 lows near $28. FCX is trading at 7 cash-flow, but EPS estimates are still getting cut. The Q1 '13 results triggered a sharp downward revision in 2013 and 2014 numbers.
US Steel (X):
When US Steel reported their Q1 '13 results, EPS and revenue estimates missed results and the steel giant looked to lower Q2 '13 guidance as well. But just like Alcoa and Freeport the stock looks to have bottomed and wants to move higher on the bad fundamental news.
US Steel's 2013 and 2014 EPS estimates have been reduced dramatically in the last 12 months, with 2013's current estimate of $0.81 down from $3.70, while 2014's estimate of $3.70 twelve months ago, while 2014's EPS current estimate of $2.06 is down from $4.46 as of 12 months ago.
We do not follow US Steel fundamentally, but note that Morningstar has an "intrinsic value" on the stock of $33 per share so X is trading at a 50% discount to what one firm thinks the shares are worth.
Agriculture and Chemicals comprise about 50% of DD's revenues, while basic materials is 18% of the company's revenue as of 2012. DuPont too had a weak Q1 '13 in terms of financial results, and also guided poorly for the 2nd quarter of 2013.
At $54 per share, DD is trading at 14 the current 2013 estimate of $3.90 and 12 the 2014 estimate of $4.38 for expected growth in 2013 and 2014 of 17% and 12%. Like the previous commodity metals companies, DuPont's earnings estimates for both 2013 and 2014 continue to get reduced, although the stock has traded much better since its mid-November, 2012 lows. However, unlike the other companies, DD is still growing year-over-year in 2012, 2013, and 2014.
Morningstar has a fair value estimate of $54 on the stock, which is right where DD peaked in terms of its trading in 2011 and 2012.
With the exception of DuPont, the three commodity metals we just listed are trading at a pretty steep discount to fair value, thanks to anemic global growth, and China's production of a lot of these metals, (like aluminum and copper), which has increased supply. If you believe in the global growth story, then these stocks make sense for a deep value investor. They require patience and an awaiting of the "next phase" of monetary policy, which is the synchronized global recovery.
DuPont's technical pattern indicates that at a high volume trade over $55, the stock will have broken out.
Another way to play this sector is through the XLB or the SPDR Basic Materials ETF. DuPont is the 2nd largest holding in the ETF at 10% of the portfolio, while Freeport is the 5th largest holding at 6%.
With Friday morning's upside nonfarm payroll surprise, the recovery in Japan, and Europe stabilizing, there is hope for this sector, but you need to believe the global economies are on the road to growth, which is a long-shot indeed.
|Mkt cap ($'s bl)||$9.24||$29.9||$2.6||$50|
|EPS - 2013||$0.44||$3.65||$0.81||$3.90|
|EPS - 2014||$0.73||$4.21||$2.06|
|EPS - 2013 growth||83%||13%||-25%||17%|
|EPS - 2014 growth||65%||15%||+150%||12%|
|Price to cash-flow||6||7||3||10|
* Source: earnings estimates ThomsonReuters
* Internal spreadsheets for AA, FCX valuation data
* Morningstar for X, DD valuation data
- Alcoa - our largest position of the 4
- US Steel - the greatest upside when the world does turn
- DuPont - the closest to "fair value" of the 4 names;