Tuesday, May 25, 2010

Correction Hits Sweet Spot; Favor FCX, CLF and NUE; Upgrade AKS - Citigroup & Merrill

Citigroup is out positive on Metals plays saying the recent correction has hit the sweet spot; They favor FCX, CLF and NUE & upgrade AK Steel (NYSE:AKS) to a Buy from Hold with a $19 target (46% upside, prev. $22).

Sweet Spot – Citi's coverage of ferrous and base metals have fallen by 26% since April, placing the current correction in line with annual bouts of 24-33% declines that marked the last cycle (2004-07), which was followed by outperformance.

Base metals, steel and iron have corrected by roughly 26% over the past several weeks on growing concerns of a slowing Chinese economy and Eurozone contagion. Citi believes caution is warranted but similar equity corrections have also represented buying opportunities in the past should these rational concerns prove more severe than reality. As illustrated above, throughout the last cycle (2001-2008), their coverage of steel, iron and base metals experienced multiple bouts of sharp share price corrections on the order of 24-41% following a steep initial appreciation on the heels of a cyclical recovery. In hindsight, many turned into buying opportunities for investors with the exception of 2008.

Key Question – The value or value-trap debate will be answered by the direction or pace of economic recovery. Citi’s base case calls for an “uneven” scenario where Europe lags. They believe metals stocks offer good value here under tempered expectations given recent declines.

Top Three Ideas – FCX is Citi's Top Pick because of high current utilization rates across global copper mines, scarcity value longer term, and Citi’s expectations for a 430k tonne deficit in 2010. Dropping their European demand growth to 0% from 6% still results in a deficit forecast of 196k tonnes. CLF is #2 where despite weaker spot iron ore, 3Q selling prices are likely to exceed guidance which suggests 2010 EPS of $7.50/sh, or 6.7x P/E. 4Q prices for CLF have yet to be determined. NUE is #3 for its leverage to the US recovery, industry leading balance sheet size and quality, high dividend yield of 3.4%, and exposure to lagging construction spending where Citi sees more upside than downside risk. They expect NUE margins to expand in 2Q as a result of lower scrap costs.

Upgrade AKS - Despite cutting their estimates and their target price to $19, the firm ise upgrading AKS to Buy following a 46% share price free fall. On their lowered numbers, AKS is trading at less than 10x 2011 P/E. Negatives appear priced-in with low sell-side ratings (2 Buy, 11 Hold and 1 Sell) and high short interest of 17 mln shares (15.5% of outstanding). Iron ore cost headwinds are well known but the market may be ignoring AKS’s stainless exposure where producers have announced base price increases of 6-9% during 2Q.

- Merrill Lynch/Bac is out with a Steel, nonferrous & coal sector call saying they remain positive following pullback, upgrade AKS & RTI Global macro concerns related to slowing growth in China and the decline in the Euro has the metals & mining sector discounting lower commodity prices. With the sharp reversal in sentiment, the firm re-evaluates their group strategy and maintain a positive view. Their group should underperform in a market correction, though they see attractive values for investors. Importantly, the firm does not expect a hard landing in China. Merrill upgrades AKS and RTI to Neutral on valuation. Their top picks (in order of preference) include CLF, ANR, BTU, and FCX. Aside from valuation upside potential and catalysts ahead, their top picks all have very clean balance sheets.

Merrill is upgrading AK Steel (NYSE:AKS) to Neutral from Underperform with a $16 target citing concerns on slower growth in electrical steel and raw material cost impacts appear discounted in valuation. They remain cautious as steel price declines and additional disclosure on raw material impacts represent near term risks. AK Steel appears well positioned in carbon steel, though profits in this business are well below electrical steel at present. While debt appears to be at manageable levels, pension/OPEB liabilities remain a consideration.

Negative raw material views appear largely discounted
AK Steel has sharply underperformed the steel group since early April (-46% vs. S&P 500 -10%). Raw material concerns have been the main overhang on the stock with the company continuing to assume a modest 30% increase in iron ore costs in 2010. Merrill expects more volatility near term as the company is expected to release a weaker mid-quarter outlook and quantify impacts from higher iron ore and met coal costs. That said, their revised PO (which values AKS at discount to group) suggests there is modest upside in the stock as profit/ton recovers toward average levels over the next 1-2 years. A strategic fix to the company’s lack of integration in iron ore can also be a positive catalyst for the stock, in their view.

Notablecalls: Needless to say, one needs to have some cojones to buy anything in this tape but buying some AKS (2 upgrades from tier-1 firms) or FCX/CLF today could yield some nice upside.

These are basically high-octane bets on general market bounce today.

Tight stops & small positions, if you do decide take the leap of faith.

1 comment:

Stock Picker said...

FCX has sold off like other players in the group like Rio.
THis is quite and dip and looks tempting. I suppose it would be in the bag for the slow dollar cost averager.