The global financial crisis (GFC) was a reality check for many across the world. Within just a few months the realization that assets don’t continuously rise was suddenly and abruptly realized.
As with every cyclical shift from bull to bear market, the market overreacted. During the bull market prices overshot, assigning lofty and overly optimistic valuations to stocks. Similarly in the subsequent bear market that savaged the S&P500 by some 40+% overshot on the downside.
Now 5 years after the crisis, many investors are in a very skeptical mindset with respect to valuations and earnings potential. The Dow has recently hit new highs and to a very large extent all we see is skepticism about the sustainability of the current market.
I think it is fair to say there is a very limited amount of optimism and little (if any) euphoria. With this in mind, I believe we are positioned for an ideal period of growth as the pervading sentiment is one of strong skepticism.
Specifically I believe the basic material sector is primed for renewed share price growth. This sector saw particularly brutal declines during the GFC. Since then the sector has struggled as companies have been challenged by the debt binge they went on prior to 2007.
However I think that the great majority of challenges and bearish headwinds have been factored into the prices of the three companies I have detailed below as my primary picks for playing a bullish recovery in the materials sector. Specifically, I believe there will be a bullish phase that will be driven by demand from India.
Alcoa Inc (NYSE:AA)
Alcoa has been the proverbial market pinata for some time now. Its share price has taken a major beating. After having hit a peak of over $40, Alcoa Inc (NYSE:AA) has declined nearly 80% to its current price of $8.62. Many pundits cite, the declining aluminum price and heavy debt burdens as the prime reasons for the decline. Perhaps this is true, what I am focused on though is Alcoa’s prospects moving forward.
I don’t believe the need for aluminum will go away anytime soon. What excites me about Alcoa Inc (NYSE:AA)’s prospects is the strong growth rate of India. With population growth expected to be nearly 20 million/ year for many years to come. India is poised to drive sustained demand for aluminum.
Think about it – India’s population is young and urbanizing. Each year another 20 million babies born and young people growing into adulthood. 20 million more people needing goods such as cutlery, microwaves, lightweight (and cheap cars). Not to mention the growth in the soft drink market (aluminum cans of soda) as India’s youth embrace the western culture.
With these broader macro trends combined with Alcoa’s fundamentals I am bullish:
A Price/Book ratio of just 0.7
Forward Price-Earnings of 9.91
And now conservative debt levels of just 53% of equity
I think Alcoa Inc (NYSE:AA) represents a long term ideal play of value and growth.
United States Steel Corporation (NYSE:X)
At the peak, United States Steel Corporation (NYSE:X) saw a share price of over $170. Currently at a tick over $20, it is fair to say, the optimism and rosy forward projections are well and truly priced out!
But with the world still turning, people still having families, enormous write downs having been worked through the system, demand is returning. I don’t believe you can increase a country’s population by 20 million/ year and not create a significant demand for raw materials – steel being one of them. I believe (as judged by the share price) this fact is under appreciated and thus Alcoa Inc (NYSE:AA) under priced.
I think there is significant value to be realized in the share price of United States Steel Corporation (NYSE:X) in the coming years as the investing world fully appreciates the reality of having to create the necessary infrastructure for 20 million new residents in just one country each year.
In addition, United States Steel Corporation (NYSE:X) has I believe conservative fundamentals:
Price/Book Ratio of 0.86
Forward Price/ Earnings of 9.32
Debt levels are on the high side but I believe are being well managed
My third pick, with playing the macro theme of renewed growth in demand of basic materials with an India centric focus is Kinross Gold Corporation (USA) (NYSE:KGC)
Kinross Gold Corporation (USA) (NYSE:KGC) has been under performing for sometime but things are starting to look up. Again, as with Alcoa Inc (NYSE:AA) and United States Steel Corporation (NYSE:X), I am bullish on Kinross Gold Corporation (USA) (NYSE:KGC) because of the strong population growth in India.
Gold is becoming more scarce (especially as central banks have begun acquiring more of it). With its firmly entrenched cultural value in India, gold has a secure place in the consumer market of India. A consumer market with 20 million people entering into each year. Again – I don’t think you can add 20 million people into a consumer market each year and not expect demand of sought after products to not increase.
As the growing middle class continue to increase their wealth and affluence, gold will increase in it’s desirability because of it’s long history as a culture centerpiece.
Kinross Gold Corporation (USA) (NYSE:KGC) is also quite conservatively priced. Some of its conservative fundamentals include:
Price/Book ratio of 0.90
Forward Price/Earnings ratio of 8.67
Debt Levels of just 26%
If you believe in the story of India population growth, then these 3 companies may be ones you might consider adding to your long term portfolio.
The article When the World Recovers Will You Profit? originally appeared on Fool.com and is written by Jarrod Bailey.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
