I have been pounding the table on basic materials stocks recently and have decided Alpha Natural Resources, Inc. (ANR) offers the most bang for your buck. The company is trading for a 60% discount to book value, has a beta of 1.67 and is up 37% over the last three months. I have initiated a long position.
One major catalyst for the sector is China announced it would invest 150 billion in infrastructure a month or so ago. This news coupled with the quantitative easing and stimulus actions by the ECB, Fed and many other central banks is fueling a rally in the basic materials sector. The five basic materials stocks covered in this article are up significantly in recent weeks.
Now I believe there are additional factors that may drive the stocks higher into the end of the year. First, I see a rotation from winners into losers coming as investors sell their winners and declare profits prior to 2012 based on the fact the capital gains tax rate may be raised significantly next year. As they sell their winners participants are rotating into the laggard which has been the basic materials sector. Charts provided by Finviz.com.
This is when things start to pick up. The consumer outlook is improving, interest rates are low, and industrial production is rising. Generally, the basic materials sector is beginning to outperform the market at this stage in the market cycle. See chart below.
Personal Graphic created based on investopedia.com's Sector Rotation: The Essentials verbiage.
I chose Alpha Natural Resources, Inc. and have started a position in the stock. The stock seems to provide the most bang for your buck based on a high risk equals high reward basis. The stock has been beaten down and is currently trading at a 60% discount to book value. Currently, ANR is on the comeback trail and is up 37% for the quarter. ANR has a beta of 1.67. Alpha just broke out of a long term downtrend. The stock has breached major long-term resistance at the $9 mark.
In the following section I will analyze ANR and compare it to four other basic materials stocks. The other stocks may present buying opportunities at current levels as well. Most of the stocks covered in this article have rallied significantly recently. Yet, the stocks are still trading at a discount and have substantial upside potential if global growth picks up. Furthermore, the stocks have recently bounced off multi-year lows yet are trading vastly below multi-year highs and have improving fundamentals.
In the following section, we will perform a review of the fundamental and technical state of each company to determine if this is the right time to start a position. The following table depicts summary statistics and Thursday's performance for the stocks. The following charts are provided by Finviz.com.
Alpha Natural Resources, Inc.
ANR is trading 68% below its 52-week high and has 12% upside potential based on the consensus mean target price of $10.36 for the company. ANR was trading Thursday for $9.52, up almost 3% for the day.
Fundamentally, ANR has some positives. EPS for the next five years is expected to rise by 20%. ANR is trading for approximately a 60% discount to book value. The company's sales are up 16% quarter over quarter. On the negative side, the company has a net profit margin of -36%; a negative ROE of -43.57% and EPS is dropping substantially quarter over quarter.
Technically, ANR looks strong. Alpha is on the comeback trail and is up 37% for the quarter. Alpha has a beta of 1.67. Alpha just broke out of a long term downtrend. The stock has breached major long-term resistance at the $9 mark. The risk/reward ratio seems favorable at this point. This could be the biggest opportunity. The company is down over thirteen fold from its 2008 high of $100. Set a stop loss and layer in if you start a position. The stock just broke out above the long-term downtrend channel. I like it here.
Peabody Energy Corp. (BTU)
Peabody is trading 43% below its 52-week high and has 18% upside potential based on the consensus mean target price of $31.62 for the company. Peabody was trading Thursday for $27.49, up over 2% for the day.
Fundamentally, Peabody has several positives. The company has a forward P/E of 14.21. Peabody is trading for 11.16 times free cash flow and 1.24 times book value. EPS for the next five years is expected to rise by 14%. The company pays a dividend with a yield of 1.27%.
Technically, the stock looks good. The stock changed trend in August and is now in an uptrend. I like the stock here. It just broke through resistance at the 200-day sma and should keep on going. This is precisely the time to start a position as many institutional investors often use the breach of the 200-day sma as a buy signal.
The company is down almost three-fold from its 2008 high of $82. The rise in natural gas prices and positive comments regarding the coal industry by both parties may also be contributing to the rise in coal stocks.
Arch Coal Inc. (ACI)
Arch Coal is trading 59% below its 52-week high and has 11% upside potential based on the consensus mean target price of $9.00 for the company. Arch Coal was trading Thursday for $8.42, up almost 4% for the day.
Fundamentally, Arch Coal has several positives. The company has a forward P/E of 14.21. Arch Coal is trading at a 45% discount to book value. Insider transactions are up 89% over the last six months. The company pays a dividend with a yield of 1.48%. On the other hand, sales, EPS and profits have been dropping.
Technically, the stock looks good. The stock changed trend in August and is now in an uptrend. The stock is exhibiting many of the same characteristics as other basic materials stocks.
The company is down almost nine-fold from its 2008 high of $70. I chose ANR over ACI based on the fact I believe ANR will be able to turn their ship around faster.
AK Steel Holding Corporation (AKS)
The company is trading 44% below its 52-week high and has 10% upside based on the consensus mean target price of $6.30 for the company. AK Steel was trading Tuesday for $5.72, basically flat for the day.
AK Steel has some fundamental positives. The company has a forward P/E of 10.21. AKS is expecting EPS to more than double next year. The company trades for approximately 10% of sales. EPS for the next five years is projected to be 22%.
Technically, the stock has been in a well-defined trading range for the last few months. The stock has moved between a high of $6.50 and low of $5 since June. The stock recently broke through major resistance at the 50 day sma and is now testing resistance at the top of the long-term trading range.
The company is down over ten-fold from its 2008 high of $70. AK Steel recently warned of a larger than expected Q3 loss as it contends with lower average per-ton selling prices, but the news seems to be already priced in at this point. The risk/reward is favorable at this point. With the housing industry showing signs of life, I see this as a buying opportunity.
CONSOL Energy Inc. (CNX)
CONSOL is trading 23% below its 52 week high and has 13% upside based on the analysts' consensus mean target price of $40.42 for the company. CONSOL was trading Thursday at $36.26, up over 1% for the day.
CONSOL has many fundamental positives. The company has a PEG ratio of .50 but a forward PE of 23.57 which is above average. CONSOL pays a dividend with a 1.40% yield with a payout ratio of 18%. On the downside, the company is trading for more than two times book value.
Technically, the stock is performing well. It has been in a well-defined uptrend since June and recently broke above long-term resistance at $35.
If you bought CONSOL on the day of my initial recommendation on July 12th, you would be up 20% to date. The stock looks good here. I would layer into the stock 10% at a time using weekly intervals to reduce risk. The coal sector seems to be on the comeback trail.
The Bottom Line
A colossal sell-off of basic materials stocks based on unprecedented macroeconomic and geopolitical trepidations has occurred over the last four years. 2008's so called Great Recession's only peer seems to be the Great Depression of the 1930s. This has created some tremendous buying opportunities in the space.
I posit the basic materials sector is at an inflection point. These stocks reacted quickly jumping sharply higher regarding the news out of China, the ECB and the Fed. The initial pop is a tell that macro-economic and geo-political conditions are beginning to favor these names. I believe we are at a major inflection point.
Furthermore, market sector rotation and end of year tax planning may play a significant part in moving these stocks high into year end. I chose Alpha Natural as my pick based on the fact I believe they have the most upside. Consequently they also have the highest risk in my opinion. ACI and AKS definitely fall into the speculative category as well. You may want to look at Peabody or CONSOL for a less risky stance.
Disclosure: I am long ANR.
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.