The metals and mining industry hasn’t been getting much love from investors, but that’s set to change this year, CFRA said in a note last week.
“The metals & mining industry could be the poster child of boom and bust economic cycles, as miners have notoriously invested in
multi-billion-dollar projects and acquired assets at the peak of cycles, leading to significant value destruction,” CFRA noted. “It appears that investors are not quick to forget the recent commodities downturn, as valuation multiples have not seen expansion, despite improving fundamentals.”
But CFRA said it expected that management teams would show capital discipline this year and return more cash to shareholders, likely in the form of dividends, driving a re-rating of the stocks.
“With the backdrop of strong fundamentals for commodities and shareholders demanding capital discipline, the free cash flow outlook for the industry is very strong,” it said. “This is especially true for domestic steel and aluminum producers, which are poised to see higher volumes and prices after President Trump announced new steel and aluminum tariffs on imported products.”
Sector valuations ‘unjustified’
CFRA also pointed at a valuation differential for the sector’s shares. The trailing enterprise value (EV) to forward earnings before interest, tax, depreciation and amortization (EBITDA) of the S&P composite 1500 index had grown to around 11.14 times by last week, up from 9.94 times at the end of 2016, it said, citing data from S&P Capital IQ.
That compares with the S&P composite 1500 metals & mining index valuation contracting to 7.06 times from 7.34 times, it noted.
Currently, that’s an “unjustified” discount of 37 percent, compared with the five-year average discount of 27 percent, it said.
“CFRA encourages investors (who might be weary of high asset valuations) to note the compelling valuation in this industry,” it said.
It highlighted four stocks it rates at Strong Buy: Alcoa, Freeport-McMoRan, Teck Resources and United States Steel.
Additionally, CFRA noted that for broader exposure to steel and aluminum, SPDR S&P Metals & Mining ETF recently had 49 percent in steel and 14 percent in aluminum companies.