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Weekday Trader
Aluminum Stocks Could Rise If Metal Price Holds
By Vito J. Racanelli
Scratch a natural resources fund manager and you probably won't find much
blood left; most of it was spilled last year thanks mainly to awful
performances by gold and other metals.=20
But commodities-based stocks can rise as well as fall and, particularly
when inventories shrink, their gains can be formidable. Case in point:
aluminum, whose producers have seen their share prices take off in 1998.
Aluminum companies were the best performing stock group last week (the Dow
Jones Aluminum group picked up 8.8%), and are the twelfth best (out of 96
groups) so far this year. Last year, they were among the laggards, picking
up a mere 5%, way behind the 30%-plus gains of the S&P 500 and not far
ahead of the much-beleaguered gold stocks.
The rise in aluminum shares come as giants like Alcan Aluminum Ltd. and
Reynolds Metals Co. have reported better-than-expected fourth-quarter
earnings, on rising aluminum prices. The average price of aluminum in the
fourth quarter was up about 11% to 72 cents per pound, from 65 cents in the
fourth quarter of 1996.
And some industry observers say that if aluminum prices continue to
rise--or even just stabilize=97these stocks remain undervalued, compared wit=
h
both their own historical valuations and the broader market. The stocks
continued to gain ground in Monday's broad-based stock market rally:
Aluminum Co. of America rose 1 11/16 to close at 78 1/16; Alumax picked up
1 1/14 to 36 1/8; Reynolds added 1 7/8 to 64 15/16, and Alcan ended the day
at 30 9/16, up 1 1/8.
Adam Rowely, a London-based metals analyst at Australian bank Macquarie
Equities Limited, says that the Asian economic crisis will obviously cut
into sales of aluminum to that region. But if Asian demand doesn't
deteriorate much from current levels, he expects 1998 prices to average 70
cents a pound-- not far from the 72.5 cents per pound average seen in 1997.=
=20
And Asian demand for the metal isn't as important as it is for crude oil,
gold and copper, some point out. "If you define Asia fairly broadly, then
it represents 15% of demand outside Japan, " says Rowely. "We aren't
predicting a turnaround in Asian demand but a pickup in the second half of
the year as destocking ends." Meanwhile, in the U.S. and Europe, whose
economies are still growing, demand has been strong, he notes.
Inventory levels are pointing to tighter supply as well. Anthony Rizzuto,
who follows the aluminum companies for Bear, Stearns & Co., says aluminum
stockpiles on the London Metals Exchange have been trending downward
since October; currently there is just a little more than six weeks of
supply in the whole world. That's near the low end of a historical range of
five to 15 weeks' backlog, adds Rizzuto, who's looking for an average
price of 80 cents per pound in 1998.
The bottom line: If the currency crises in Asia don't worsen and drag down
the rest of the world, "[aluminum's] fundamentals look favorable over the
next two to three years...and the market [now] looks pretty balanced at
worst," says Richard Aldrich, an analyst at Lehman Brothers. Among the five
North American producers, Aldrich rates Alumax. a Buy; the rest--Reynolds,
Alcoa, Alcan and Kaiser Aluminum=97he rates Outperform.
Aluminum stocks have been so far behind the market that their valuations
look cheap even after their nice price run this year=97from Kaiser's low of
nine times First Call's mean 1998 estimated earnings to a P/E of 13x for
Alcoa, which is in the Dow Jones Industrial Average. By comparison, the
lowest annualized earnings growth projected for any of these companies over
the next two years is about 23%.=20
And, Aldrich adds, aluminum stocks historically sell at a 50% discount to
the S&P 500's multiple as they approach the top of their earnings cycle.
"They are nowhere near the top of the cycle," he asserts. "So, if you
believe the earnings peak is 2000, and you assume an eight to nine times
P/E, then most of these stocks [will] double," he maintains.=20
Another bull on aluminum stocks is John Neff, the retired portfolio
manager of Vanguard Windsor fund and a Barron's Roundtable participant. He
believes that the expected 1% annual capacity increases in the industry,
combined with 3% to 4% demand growth --"after we get through this Asia
thing"--will lead to tight supply in the not-too-distant future. Neff's
favorite: Kaiser Aluminum, which sells at less than nine times 1998
projected earnings.
Other investors remain a bit gun-shy. Alan Wapnick, a portfolio manager at
Saddle River, N.J.-based Lexington Global Asset Management, doesn't own
aluminum stocks, though he admits to peeking at them lately because, he
says, they look cheap. But he's holding back because of "concern=85that th=
e
bad news out of Asia isn't done." Even the bullish Aldrich acknowledges
that there's lots of downside risk with commodity-based stocks like the
aluminum companies. If Asian demand really falls apart, he estimates the
stocks could lose 20% to 25% of their current value.=20
As investors have learned in recent years, natural resource shares are
among the market's most volatile and unpredictable bets. But short of any
new deterioration in Asia, aluminum stocks may have seen their worst days
for now=97and could have room to run.=20
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