The metals and mining industry within the basic materials sector has been receiving some favorable comments from the start of the year given some improvement in the macro-environment dynamics. This has led to some capital appreciation of players within this space. However, I still believe that there are some players out there that haven’t realized fully from the ongoing improvement sector-related dynamics. Here are some of them:
Reliance Steel & Aluminum (NYSE:RS)
The stock is levered to the US recovery without direct global exposure. The company gets 95% of its revenues from the US. The company has the following characteristics that make it an attractive option among the steel players:
1) Industry-leading size & scale,
2) Diversified end market mix/product mix,
3) Strong margin sustainability,
4) Stellar track record of acquisitive growth,
5) Adequate liquidity reserves – $800 million in revolver availability.
I have already covered this company in one of my older posts. There I mentioned that the company has one of the best product mixes to benefit from steel demand recovery in the US. It deals in carbon steel, aluminum and stainless steel. Moreover, the company is not expected to face any major raw material cost headwinds. Additionally, I believe that if/when we do get a recovery in non-residential construction, normalized EPS could be $7/share to $8/share, which implies an $84 to $96 share price based on its historical P/E multiple of 12.
United States Steel Corporation (NYSE:X)
There are a number of compelling industry and company specific data points that suggest that 4Q will prove the earnings trough, with an expected steel price recovery pushing the shares higher over the next three months given that:
1) The company is highly levered to steel prices, autos in particular, which are expected to continue to improve in the coming months. The company gets 30% of its revenues from the auto sector.
2) A reversal in rig counts is expected, which sets the stage for a potential OCTG demand recovery in 2H’13. The Oil Country Tubular Goods are pipe and tube products used in the petroleum industry. The sell-side claims that the rig count will see the bottom by the end of the first half of this year.
3) Seasonality remains supportive.
Peabody Energy Corporation (NYSE:BTU)
Peabody remains the top pick in the coal sector, given its:
1) Global diversification and organic Australian growth: Australian assets provide direct access to Pacific Basin markets. 20-30% volume growth is expected in Australia by 2015, and Peabody will be one of the main beneficiaries, given that the company is the largest producer in the PRB. It is important to note that the coal mined from PRB facilities is cheaper as compared to Appalachian coal or coal obtained from the Illinois Basin. The PRB coal is competitive versus the natural gas price at around $3/btu. By this I mean that natural gas will not be a cheaper substitute for the PRB coal if its price crosses the $3/btu mark. The PRB coal is of low quality as compared to coal obtained from Illinois Basin or Appalachian coal. The coal of the Illinois Basin becomes competitive versus the natural gas price in the range of $3.5-$4. Similarly, the Appalachian coal becomes competitive versus the natural gas price at $5. Given that the current gas spot prices are hovering around $3.3/btu mark, the demand for PRB coal is high.
2) Significantly growing leverage to metallurgical coal markets (potential 40-55% increase in met coal/PCI sales by 2015).
3) Compelling Valuation, trading at a 17% discount to historical multiples.
Foolish Bottom Line
The steel sector has already received many bullish comments from the Street. Moreover, players like Peabody are destined to grow given a sharp rebound in natural gas prices and compelling valuations. Talking holistically, these three players look the most attractive in the metals & mining space.
The article 3 Gems in the Metals & Mining Space originally appeared on Fool.com and is written by Masam Abbas.
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