Base metals seen heating up
Guy Dixon (gam)
Are base metals poised for a comeback?
With the economy on a hot streak, shares in base metal producers could be primed to lose their reputation as those heavy-industry stocks with the lightweight returns.
The rationale is simple. When the economy reheats, demand for industrial metals normally rises too, making shares of heavy hitters such as Alcan Inc., Inco Ltd. and Noranda Inc. more attractive.
Merrill Lynch Canada Inc. is among those who believe base metals will regain the lustre they lost when the economy started slowing.
In fact, with many economic indicators pointing to an apparent recovery, Merrill now has an overweight position not just in base metals, but in economically cyclical stocks in general.
"In fact, if you look at the charts of a lot of these stocks, most of them bottomed -- at least on a relative strength basis -- back in late 2000," said Merrill's market strategist Robert Spector. "Even before we were talking recession, these stocks were making bottoms."
This has turned around as the demand for metals has improved and many metal producers anticipate stronger bottom lines.
"Now that the demand side is kicking in, we are seeing earnings upgrades -- because of higher commodity prices -- and they are starting to get access to capital, which is an additional positive," Mr. Spector said.
Base metal shares have actually been on a long, protracted comeback since their latest trough in September. As the economy geared down last summer, so too did the Toronto Stock Exchange (TSX) metals and minerals subindex, which plummeted more than 34 per cent from May to September, 2001.
Between the end of September and the end of April, the subindex gained 30.1 per cent, though this is still below the break-even point from a year ago. Base metals also pale in comparison with the TSX gold and precious minerals, which soared 41.4 per cent in the 12 months ended April 30. Base metals lost 2.7 per cent in that period.
Much of this has been the result of the roller-coaster performance of Alcan shares, which dominate the base metals subindex with a weighting of around 50 per cent. The next biggest stock is Inco at only 15 per cent. Alcan is also 2.6 per cent of the overall TSX 300-stock index, making it one of the most obvious choices for investors looking to play cyclical swings in the economy.
After gradually improving from last autumn and early 2002, Alcan fell sharply after the company reported a lower quarterly profit of $86-million (U.S.) in the first quarter, compared with $135-million a year ago.
But at the company's recent annual general meeting, Alcan spent a great deal of time stressing its restructuring plan aimed at streamlining costs and doubling the value of the company every five years.
"The restructuring initiated last October is expected to generate incremental pretax earnings of $200-million -- and this is on top of the $200-million improvement expected from merger synergies," said Alcan's president and chief executive officer Travis Engen.
Among its recent acquisitions, Alcan particularly noted its purchase of a 20-per-cent interest in Quebec aluminum smelter Aluminerie Alouette. "We see Alouette as an excellent opportunity to enhance Alcan's asset base in primary metal," Mr. Engen said.
"So economic circumstances notwithstanding, we continue to lay the foundations for future growth."
Some analysts also point to this focus on restructuring and cost-cutting, while still increasing the size of the business, as one of the most enticing aspects of base metal stocks and other cyclicals.
"Many older cyclical industries such as mining, metals, pulp and paper, steel, cement and petrochemicals, which lacked the easy access to risk capital enjoyed by [technology] companies in recent years, have been minimizing capital expenditure over the last decade," Clément Gignac, chief economist and strategist at National Bank Financial, said in a recent report.
Consequently, "many of these industries are able to pass price increases on to customers and thus improve their operating margins."
As Merrill Lynch's Mr. Spector said, "you can tell a supply story. You can tell a demand story. You can tell a good management story. You can tell another story about how a lot of these sectors are still undervalued. They've had good runs, but relative to where they typically trade, there still could be some expansion in earnings and cash flow."
That's the rationale. It's fairly simple. The next step is to see how closely reality matches this time-honoured logic. |
