Overview
We were in the midst of a sell off based on macroeconomic and geopolitical issues. Even so, we may have just hit an inflection point. Often, this is precisely the time to pick up shares in out of favor stocks. The Dow topped 13,000 and logged its best three day rally for 2012. The Dow rose above 13,000 for the first time since May. Optimism that the Federal Reserve and the ECB may provide further impetus to resuscitate the global economy was perceived as the main catalyst. I have chosen five out of favor stocks recently bouncing off multi-year lows to consider. These are contrarian investing value ideas.
A contrarian believes that certain crowd behavior among investors can lead to exploitable opportunities. Pervasive cynicism about a stock or sector can drive the price so low that it exaggerates the investment's perils and belittles its future prospects. Identifying and seizing on these opportunities is a well-known investing tactic utilized by many legendary investing experts.
Company Reviews
These five basic materials stocks may present buying opportunities at current levels. The stocks covered in this article are trading on average 60% below their 52 week highs and have an average upside potential of 76% based on consensus analysts' mean price targets. Furthermore, the stocks have recently bounced off multi-year lows posting an average gain of 5% on Friday. Furthermore, these stocks have solid EPS growth projections for next year.
In the following sections we will take a closer look at these stocks to determine if the mean price targets are justified. We will perform a review of the fundamental and technical state of each company. Additionally, we will discern if any upside potential exists based on sector, industry or company specific catalyst. The following table depicts summary statistics and Friday's performance for the stocks.
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AK Steel Holding Corporation (AKS)
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AK Steel is trading well below its consensus estimates and its 52 week high. The company is trading 61% below its 52 week high and has 40% upside based on the analysts' consensus mean target price of $6.94 for the company. AK Steel closed Friday at $4.95, up over 6% for the day.
AK Steel has some fundamental positives. The company has a forward P/E of 6.60. AKS is expecting EPS to grow significantly next year and pays a dividend yielding 4.04%. EPS for the next five years is expected to rise by 26%. The company trades for 1.5 time book value and for less than 10% of sales.
AK Steel recently reported EPS of $0.10 for the second quarter which beat estimates by $0.05 and revenue of $1.54B which was in-line. AK also suspended its dividend to save the company $22M/year and "help enhance the company's financial flexibility and further support capital needs for the business."
In a separate move on Friday, AK Steel said it is increasing current spot market base prices for all carbon flat-rolled steel products by $40 per ton, effective immediately with new orders. This bodes well for the company's bottom line. I would wait a day or two prior to starting a position based on the current spike in share prices prior to starting a position, nonetheless, AKS looks good here.
Peabody Energy Corp. (BTU)
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Peabody is trading well below its consensus estimates and its 52 week high. The company is trading 65% below its 52 week high and has 90% upside based on the analysts' consensus mean target price of $39.50 for the company. Peabody was trading Friday for $22.80, up nearly 6% for the day.
Fundamentally, Peabody has several positives. The company has a forward P/E of 6.50. Peabody is trading for 7.79 times free cash flow and one times book value. EPS next year is expected to rise by 26.98%. Insider ownership is up 158% over the past six months and the company pays a dividend with a yield of 1.63%.
Peabody recently reported EPS of $0.73 for the second quarter beating estimates by $0.20. Revenues of $2B were up by 1% year over year but missed expectations by $60M. Q2 sales volumes were 57.4M tons, on par with the prior year as increases from Australia and in trading and brokerage offset lower U.S. production.
Peabody recently entered into an agreement with Kinder Morgan Partners (KMP) to expand the Gulf Coast coal-export platform for its Colorado, Powder River Basin and Illinois Basin coal products. The additional access could increase Peabody's Gulf coal export capacity by 5M-7M tons/year starting in 2014. This will allow increased service to its international customer base. Peabody is trading at 2008 lows. I don't think we are in for another great recession. The stock looks like a buying opportunity at this distressed level.
Cliffs Natural Resources Inc. (CLF)
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Cliffs is trading well below its consensus estimates and its 52 week high. The company is trading 58% below its 52 week high and has 97% upside based on the analysts' consensus mean target price of $77.44 for the company. Cliffs was trading Friday for $39.39, up over 2% for the day.
Fundamentally, Cliffs has several positives. The company has a forward P/E of 4.19. Cliffs is trading for 6.55 times free cash flow and slightly more than tangible book value. EPS next year is expected to rise by 20.36%. The company pays a dividend with a yield of 6.35% and has a net profit margin of 26.16%.
Cliffs shares plunged 10.2% after Q2 earnings slumped 37% year over year on lower sales margins and higher expenses. The miner warned of rising costs at its Canadian operations. FBR Capital downgraded its rating and cuts its target price to $56 from $102, citing Canadian struggles and global economic concerns that continue to weigh on iron ore prices. I would wait for some type of positive update from management prior to starting a position.
Walter Energy, Inc. (WLT)
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Walter is trading well below its consensus estimates and its 52 week high. The company is trading 73% below its 52 week high and has 96% upside based on the analysts' consensus mean target price of $66.62 for the company. Walter was trading Friday for $34.03, up nearly 6% for the day.
Fundamentally, Walter has several positives. The company has a forward P/E of 5.63. Walter has a PEG ratio of .51 and trades for book value. EPS next year is expected to rise by 74%. The company pays a dividend with a yield of 1.47% and has a net profit margin of 11.02%. sales are up 50% quarter over quarter.
Walter is currently the third largest producer of premium coking coal in the world. Low volatility hard coking coal is a scarce steel making component. With Walter trading at multi-year lows, buy out rumors have been swirling for quite a while. The potential change in the global outlook recently spurred by developments in Europe could be the catalyst to bring a deal to fruition or turnaround the company's prospects. I like the stock here.
United States Steel Corp. (X)
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US Steel is trading well below its consensus estimates and its 52 week high. The company is trading 58% below its 52 week high and has 60% potential upside based on the analysts' consensus mean target price of $30.11 for the company. US Steel was trading Friday for $18.81, down over 4% for the day.
Fundamentally, US Steel has some positives. The company has a forward P/E of 6.62. US Steel is trading for 78% of book value. EPS next year is expected to rise by 106%. Insider ownership is up 25% over the past six months and the company pays a dividend of 1%.
Imperial Capital recently initiated coverage on the company with an Outperform rating and a $26.50 price target. AK Steel beating estimates bodes well for US Steel. The sentiment on the steel industry is so low, I think U.S. Steel may surprise when they announce earnings on July 31st. The risk reward ratio looks positive for long trades at this level.
Conclusion
Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.
This little-known quote is credited to John Templeton. Sir John Templeton was a legendary investor who used a contrarian approach to investing. Templeton took contrarian investing to the extreme. Templeton stated contrarian investing wasn't simply investing against the grain but buying into companies hitting rock bottom or what he called "points of maximum pessimism." I would say these stocks definitely fit the bill.
China and India are growing by leaps and bounds even though they may have slowed somewhat. They continue to increase strategic reserve stockpiles of basic materials. Couple this with the possibility of a second half rebound for the U.S. and Europe spurred by the Fed and the ECB and you have a recipe for a major rebound in these stocks.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. You must determine if these investments are suitable for you. If you choose to start a position in any stock, I suggest layering in a quarter at a time to reduce risk and set a 5% trailing stop loss in order to minimize losses further if you wish.
