I'm a Buyer in This Selloff

I always look at absolutes. Growth rates are important, but when production capacities are tight and backlogs are high, absolute supply and demand is what matters. When a company is in a situation where demand for its products is high and global supply is low, the cash flow will keep coming. So in this volatile market, I am buying stocks.

Absolute demand is still going up.

Slower growth does not always translate into less absolute demand. For example, titanium metal is in such high demand that producer Allegheny Technologies (ATI) has a production backlog worth over $1 billion. Sure, this growth rate is lower than a year ago. But the absolute measurement of orders is through the roof.

Where is all of this demand coming from? To pick one source, the aerospace industry is in desperate need. Boeing's (BA) backlog is worth approximately $263 billion (including over 7,700 commercial aircraft). This demand is not just from the U.S. A large portion comes from international sources. Globalization means higher demand for some industrial products. And titanium is one of them.

Absolute production capacity cannot keep up with demand.

Sticking with the titanium example, it takes years to build new titanium capacity. It takes even longer to generate new supply of the raw materials needed to make titanium. Too few production plants and materials means capacity takes a long time to grow.

Taken together, in this particular case, I will be buying more ATI.

Conclusion: Absolute Cash Flow for Some Companies Will Continue to Increase. In the industries I study, production capacities are fixed. Global demand is still not met. This means backorders continue to mount. And prices for these items will rise. Price increases and continued volume demand mean more cash flow for some companies.

In this environment, you must take a view and act. I am taking advantage of the panic selling in the market and buying stocks that are cheaper than usual. High backlogs will eventually show investors that cash flow is still growing.

Disclosure: Author is long ATI

Comments

[Frank Li:]

Interesting article -- thank you. Two questions:

1. Stocks aren't just about absolute numbers; they're about expectations, ie. what's priced in. Aren't stock prices already pricing in the supply and demand characteristics you mention?

2. The reason global markets are falling is because the mortgage crisis suggests a coming slow down in US demand. And much of the global growth boom is dependent on US consumer demand. Won't that impact the demand for commodities, like titanium?

2007 Nov 23 07:38 AM

[Jaimi Goodf...:]

Hey thanks for writing and sorry for the delay...I was unaware they published this article here. It would be great if you also looked at my follow-up articles on my company website, vestopia.com.

Excellent questions...

1. I view infrastructure demand as a separate, global, secular story, with ample global funding to support healthy backlogs. I believe that many expectations are based on a shorter time horizon than what these particular industries will actually have. That's why I believe certain securities are undervalued: the cycle will last longer than people think (and this will prove out over time).

2. Absolutely agree...the mortgage crisis is trickling down the U.S. landscape and into other global markets. One of the assumptions I make in my case on basic materials companies is the end demand is dependent more on end markets experiencing secular growth, away from the usual cyclical demand we see in other industries. Of course one day these industries will fall back into a regular cycle like the others...but I believe that day hasn't happened yet.

In the case of titanium, there is a secular shift occuring in the manufacturing of some capital goods. Materials such as titanium and carbon fiber are replacing metals that are heavier and have less strength. For example, titanium and other composite materials are replacing steel and aluminum parts on aircraft. Similar substitutions are occuring in tubing.

Hope to hear from you again!

2008 Jan 28 08:11 PM