What follows is a list of basic materials companies with various degrees of upside. They cover a variety of industries: mining, chemicals, and steel. I find that upside can vary substantially within industries and even between industries. My favorite pick of the five highlighted herein is ArcelorMittal (MT). I like the company's strong spread between past and forward multiples, the high dividend yield, and top management. All of these companies are highly volatile, so they have a high variance between bull and bear cases.
Alcoa trades at a respective 29x and 10.3x past and forward earnings with a dividend yield of 1.2%. Consensus estimates for Alcoa's EPS forecast that it will decline by 22.2% to $0.56 in 2012, and then grow by 71.4% and 22.9% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $0.92, the stock would hit $12.88 for 30.8% upside.
This aluminum producer has seen dramatic declines in capital spending and, in my view, the bar has been set unreasonably low. This was confirmed during the first quarter earnings call when Alcoa solidly beat analyst expectations on both the top and bottom lines. Aluminum demand was far better than what many bears had you believe, and I think that this sentiment reversal could be the beginning of a bull run.
Huntsman trades at a respective 14.2x and 6.6x past and forward earnings, with a dividend yield of 2.8%. Consensus estimates for Huntsman's EPS forecast that it will grow by 7.7% to $1.82 in 2012, and then by 18.1% and 20.9% in the following two years. Assuming a multiple of 9x and a conservative 2013 EPS of $2.06, the stock would hit $18.81 for 32.3% upside.
During the fourth quarter earnings call, MDI sales increased 6% y-o-y and indicates meaningful leverage to the underlying GDP. Slowing demand (as revealed by slower consumer purchases) is a consistent seasonal trend. At the same time, propylene oxide and MTBE have meaningfully catalyzed free cash flow despite margin compressions. Given that the stock is 120% more volatile than the broader market, I recommend it only for those willing to take on risk.
ArcelorMittal trades at a respective 19.9x and 5.5x past and forward earnings, with a dividend yield of 4.3%. Consensus estimates for ArcelorMittal's EPS forecast that it will grow by 50% to $1.94 in 2012, and then by 63.1% and 16% in the following two years. Assuming a multiple of 8.5x and a conservative 2013 EPS of $3.12, the stock would hit $26.52 for 53.5% upside.
Of the companies highlighted in this report. ArcelorMittal has the highest dividend yield. This dividend yield properly accounts for the risk inherent in the beta of 2.2. What makes me so attracted to the company is that it is trading near its 10-year low, less than half of book value. This is also substantially below peers. Fortunately, the bull case is supported by the elevated level of call options.
US Steel (X)
US Steel trades at 7.1x forward earnings, with a dividend yield of only 0.7%. Consensus estimates for US Steel's EPS forecast that it will turn positive at $2.63 in 2012, and then grow by 50.2% and 20.3% in the following two years. Assuming a multiple of 8.5x and a conservative 2013 EPS of $3.89, the stock would hit $33.07 for 17.3% upside.
US Steel is the domestic version of ArcelorMittal and, with that title, comes the costs of greater union challenges. The company bled in 2011 and remains a highly speculative investment, especially in the light of uncertainty in infrastructure spending. With a beta of 2.4, the company is also the most volatile of the stocks mentioned herein. I would thus recommend selling for now.
Dow Chemical (DOW)
Dow trades at a respective 16.3x and 9.7x past and forward earnings, with a dividend yield of 3.9%. Consensus estimates for Dow's EPS forecast that it will grow by 5.5% to $2.68 in 2012, and then by 25.4% and 21.7% in the following two years. Assuming a multiple of 9x and a conservative 2013 EPS of $3.31, the stock would hit $29.79 for 10.3% downside.
While Dow is a more recognizable chemical producer than Huntsman, it should not be trading at the premium that it is right now. Both stocks are highly volatile and, insofar as chemicals takeoff, Huntsman will likely outperform Dow anyway. Consequentially, I do not believe the risk/reward is favorable for Dow right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.