I think investors should turn their attention to the basic materials sector, which is one of the most undervalued sectors in the market today. The Steel & Iron sector is down -30.75% during the past 3 months. Steel stocks have been hammered with competitors AK Steel (AKS), Mittal Steel (MT), and Nucor (NUE) hitting their 52 week lows this past week.
But rather than chasing gold stocks trading near their 52-week highs, another, less shiny metal looks far more intriguing. . .
I'm referring to steel, specifically, steel company stocks.
Steel manufacturing companies were beaten down during the lows of 2009 and many of these stocks still trade at significant discounts to their fair value. Now that the economy is gradually recovering, steel companies stand to benefit from the return of global demand to the sector.
My favorite pick in this sector is United States Steel Corporation (X), the nation's largest integrated steel producer. U.S. Steel has always been an industry stalwart, but due to the cyclical nature of the steel industry, the company fell on tough times during the recession. This caused the company to report massive losses during 2008 and 2009. But things are looking up for U.S. Steel, as losses are decelerating and profitability is on the horizon.
The biggest threat to the steel industry is a protracted recession leading to lower than expected consumer demand from automobile manufacturers and construction companies. Another threat is China, which has been building up large amounts of steel inventory and is gaining greater pricing power in the steel market.
But U.S. Steel has a leg up on the competition.
Since nearly 70 cents of every dollar is spent on material costs, controlling raw materials costs is key for survival in the industry. This is what separates U.S. Steel from the herd. The firm has lower material costs than many competitors because it controls its own raw material suppliers through its domestic iron ore mines. Competitors don't control their own raw materials supply are forced to pay spot prices, which have more than doubled in the past year.
Last quarter, U.S. Steel posted $3.9 billion in revenue, an increase of +42% during last year. Analysts were expecting a loss of $1.43 a share for the quarter, but the company beat expectations, only losing -$1.10 a share. The company is forecasting a return to profitability for the current quarter with a profit of $0.59 a share.
U.S. Steel expects the quarterly profit to not simply be a one-off event. For the full year, it expects to earn $2.19 a share and revenue is expected to grow more than +60% year-over-year.
Action to Take --> U.S. Steel looks really cheap. The average EPS estimate for U.S. Steel in 2011 is $5.94, which means the stock is trading at a very attractive 7.4 times estimated earnings. This is incredibly low for an industry that trades for 16.8 times earnings on average.
The company has one of the best balance sheets in the entire industry, with 1.4 billion in cash and $9.67 in cash per share. Earnings are expected to grow +30% annually during the next five years, nearly twice the industry average of +16%. Even if earnings come in at the low end of estimates, U.S. Steel would still be trading at just 8 times next year's earnings. Investors in the stock are getting a blue chip company with great growth potential for pennies on the dollar.