Worst Stocks to Reverse With Commodity Profits Rising 18%

Oct. 7 (Bloomberg) -- Bill O'Neill, head of the Chief Investment Office at UBS Wealth Management Research, talks about his strategy for U.S. stocks and emerging-market bonds. He speaks with Anna Edwards and Mark Barton on Bloomberg Television's "Countdown." (Source: Bloomberg)

Commodity stocks, lagging behind the Standard & Poor’s 500 Index by the most in 15 years, are poised to rally as analysts estimate profits will rise almost twice as fast as the rest of U.S. industry in 2014.

Mining companies and chemical producers in the S&P 500 will increase earnings by 18 percent in 2014, compared with a 11 percent gain for the equity gauge, according to the average of more than 9,000 estimates compiled by Bloomberg. Commodity stocks were the worst-performing S&P 500 group during the first six months of the year, before climbing the most in almost two years last quarter. Raw-materials companies are on track to lag behind the U.S. stock index for a third straight year, the longest stretch since 1998.

Bulls say stocks such as Freeport-McMoRan Copper & Gold Inc., DuPont Co. (DD) and LyondellBasell Industries NV (LYB) will continue to rebound as manufacturing expands in China, Europe and the U.S., spurring the fastest profit growth in three years for raw-material producers. Bears says the gains will be short-lived because the commodities super cycle is over and demand for metals and chemicals isn’t growing fast enough at a time when everything from copper to nickel and corn head into surpluses in the next year.

Photographer: Jay LaPrete/Bloomberg

Employee Kenneth Horsley paints a car with DuPont Co. auto-paint at Haydocy Automotive in Columbus, Ohio. Close

Employee Kenneth Horsley paints a car with DuPont Co. auto-paint at Haydocy Automotive in Columbus, Ohio.

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Photographer: Jay LaPrete/Bloomberg

Employee Kenneth Horsley paints a car with DuPont Co. auto-paint at Haydocy Automotive in Columbus, Ohio.

“There’s still problems, but I think it’s time to buy,” Don Hodges, whose Hodges Fund has beaten 99 percent of its peers in the past year, said in a phone interview. The Dallas-based firm oversees $1.3 billion. “China over the next 20 years is going to be an awesome economy requiring all kinds of infrastructure.”

‘Shockingly Low’

Mining stocks are bargains after declines in the past two years, said Hodges, who recently bought shares of Freeport-McMoRan (FCX) and U.S. Steel Corp. The selloff since the start of 2011 has erased almost half of the market value from a gauge of seven S&P 500 metal producers, data compiled by Bloomberg show. The price-earnings ratio for Phoenix-based Freeport, the world’s largest publicly traded copper producer, has dropped 24 percent since the beginning of 2010 to 11.5.

“I see the downside risk very low at these prices,” he said. “They’re shockingly low. It’s as if there will never be another good day, and I think there will be.”

The best year for American auto sales since 2007 is boosting profits at Charlotte, North Carolina-based Nucor Corp. (NUE), the largest U.S. steelmaker by market value. The price of hot-rolled steel coil in the U.S. Midwest, a benchmark product, climbed 1.6 percent to average $645 a short ton last quarter, from $635 in the same period last year.

Photographer: Patrick Fallon/Bloomberg

The best year for American auto sales since 2007 is boosting profits at Charlotte, North Carolina-based Nucor Corp., the largest U.S. steelmaker by market value. Close

The best year for American auto sales since 2007 is boosting profits at Charlotte,... Read More

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Photographer: Patrick Fallon/Bloomberg

The best year for American auto sales since 2007 is boosting profits at Charlotte, North Carolina-based Nucor Corp., the largest U.S. steelmaker by market value.

Asphalt, Cement

Vulcan Materials Co. (VMC), an asphalt and cement supplier, is projected to return to profitability for the first time since 2009, according to analysts’ estimates compiled by Bloomberg. Federal spending on highway construction has risen 11 percent this year, reaching the highest level since 2010, according to Bloomberg Industries research.

The S&P 500 gauge of raw-material producers is made up of companies that manufacture chemicals, plastics, construction materials, packaging products, metals and minerals. It excludes oil and natural gas firms, such as Exxon Mobil Corp., and crop processors, like Archer-Daniels-Midland Co.

Earnings season starts tomorrow with Alcoa Inc. scheduled to release third-quarter results after the U.S. market closes. Profit at the New-York-based aluminum producer probably doubled during the quarter to 6 cents a share amid higher demand from the aircraft and automotive industries, according to analysts’ estimates compiled by Bloomberg.

Budget Stalemate

S&P 500 companies may boost third-quarter profit by 1.7 percent, the slowest pace in a year, the estimates show. The U.S. equity benchmark fell 0.1 percent to 1,690.50 last week after the first government shutdown in 17 years and weaker-than-forecast growth in service industries. The 31 companies in the S&P Materials Index rose 0.8 percent for the week, the second-biggest gain among 10 main industries.

Stocks retreated as the stalemate between congressional Republicans and Democrats raised concern of a default if lawmakers can’t agree to raise the debt ceiling by the time the government runs out of borrowing authority. Bill Gross of Pacific Investment Management Co. and BlackRock Inc.’s Larry Fink said last week that the standoff will be resolved soon.

The S&P 500 dropped 0.9 percent to 1,676.12 at 4 p.m. in New York today as Speaker John Boehner said the House can’t pass an increase to the U.S. debt limit without packaging it with other provisions.

Layer In

Commodity shares have lagged behind the market this year as China, the world’s biggest consumer of everything from copper to coal, grows at the slowest pace in more than two decades. Raw-material producers have climbed 13 percent, the fourth-smallest advance among groups in the S&P 500. The U.S. equity benchmark is on track for the biggest annual gain since 2009, rallying 19 percent and bringing the gains since the start of the bull market to 150 percent.

“We are looking for opportunities to layer in because I do think an awful lot of bad news has been priced into the stocks,” said Leo Grohowski, chief investment officer of New York-based BNY Mellon Wealth Management, which oversees more than $175 billion of client assets. He said the firm is underweight raw-material companies.

The last time commodity stocks underperformed the S&P 500 for this long was in the four years through 1998, when technology companies soared during the Internet boom. After the bubble burst, shares of mining companies and chemical producers gained momentum as China’s economy accelerated, helping lead the bull market between 2002 and 2007.

Riskier Securities

China’s rise to the world’s second-largest economy was fueled by gross domestic product growing an average 9.3 percent a year during the decade through 2010, data compiled by Bloomberg show. U.S. commodity stocks rallied 82 percent and the S&P GSCI gauge of 24 raw materials more than doubled. In those 10 years, the S&P 500 declined 4.7 percent.

A rally in commodity stocks shows investors are favoring companies with profits most sensitive to changes in the economy and riskier securities, according to Hayes Miller, who helps oversee about $57 billion as the Boston-based head of multi-asset allocation in North America at Baring Asset Management Inc. That’s a sign the bull market will continue, he said.

“This begins a segment where the market can grind higher for quite some time,” Miller said by phone on Oct. 3. “It’s about growth. It’s about shift from yield.”

Quarterly Return

The gauge of raw-material producers gained 9.7 percent in the third quarter as Chinese manufacturing and exports climbed, compared with a 4.7 percent rise in the S&P 500. Utilities and telephone companies, which offer shareholders the highest dividend payments, posted the only declines among the S&P 500 industries last quarter.

Investors are starting to price in faster earnings growth for the industry in 2014. While income at the S&P 500 group rose 0.7 percent in the third quarter, the pace will accelerate to 16 percent in the last three months of the year, according to estimates tracked by Bloomberg. Analyst predictions for 2014 earnings growth of 18 percent would represent the biggest increase since 2011.

Valuations for mining and metals companies are too expensive and the shares have further to fall should China’s economy weaken, according to Zach Jonson, the director of fund management at ICON Advisers Inc. Allegheny Technologies Inc. (ATI), a Pittsburgh-based steel producer, and Alcoa trade at a price-earnings ratio above 40, the highest among S&P 500 commodity shares, data compiled by Bloomberg show.

Valuation Shift

“I’m still not ready to flip the switch to become extremely bullish,” Jonson said in a phone interview from Greenwood Village, Colorado. His firm manages about $1.5 billion, including the ICON Materials Fund that has beaten 92 percent of its peers in the past year. “We’re just not seeing the valuation shift like we’d like to.”

The measure of S&P 500 raw-materials companies is valued at 18.8 times reported operating earnings, the third-highest level among the 10 main industries, data compiled by Bloomberg show. The price-earnings ratio for the group is up 16 percent this year, compared with a 15 percent increase for the S&P 500.

Goldman Sachs Group Inc. forecast in September that its favored gauge, the S&P GSCI Enhanced Commodity Index, will fall 2 percent in 12 months, with declines in energy, precious metals, agriculture and livestock. Barclays Plc says production of aluminum, copper, nickel and zinc will exceed demand next year and the London-based International Grains Council expects expanding global production of wheat, corn, rice and soybeans.

Monsanto Earnings

Monsanto Co. (MON), the world’s largest seed supplier and the top-weighted company in the index of commodity companies, last week estimated annual profit that trailed analysts’ estimates. Corn has fallen 42 percent in the past year amid forecasts for a record crop in the U.S., the world’s biggest grower. Modified corn seed is Monsanto’s largest business.

Howard Ward, the chief investment officer for growth equity at Gamco Investors Inc., said he’s bullish on companies that produce fertilizers and metals used to build planes and cars. The Rye, New York-based firm owns shares of Wilmington, Delaware-based DuPont, the biggest U.S. chemical maker.

“Not all materials stocks are created equal,” Ward said in a phone interview on Oct. 3. “There are other materials sector companies with brighter prospects due to exposure to agriculture or an upturn in U.S. manufacturing and housing construction.”

Super Cycle

Commodity supply constraints and demand from emerging markets mean it’s premature to talk about the death of the super cycle that brought a longer-than-average period of rising prices, McKinsey & Co. said in a Sept. 26 report. The New York-based consulting firm said producers are being forced deeper into remote areas of the world to secure supplies that require increasingly sophisticated technology to extract as consumption expands.

LyondellBasell has benefited from the boom in natural gas production from U.S. shale formations that pushed prices down 52 percent in the past five years.

The company produces ethylene, a chemical used in everything from shampoo to garbage bags, from natural gas at about 10 cents a pound, Doug Pike, the company’s vice president of investor relations, said at a conference on Aug. 13. That’s a lower cost compared with companies in Europe and Asia that make ethylene from crude oil for about 50 cents a pound, he said. Analysts predict the Houston-based firm will boost profit 17 percent next year. The shares are up 32 percent in 2013.

Housing Recovery

The housing recovery will boost earnings at Vulcan Materials as demand for building materials increases, Chief Executive Officer Donald James said on an Aug. 1 call with analysts. The Birmingham, Alabama-based company may earn 63 cents a share next year, compared with a loss of 10 cents a share in 2013, according to analyst estimates compiled by Bloomberg. Vulcan shares have gained 1.5 percent this year.

Allegheny Technologies, which produces specialty metals used in manufacturing, is poised to boost profit to $1.31 a share next year, from 21 cents in 2013, analyst estimates compiled by Bloomberg show. Prices for the company’s key raw materials are near a bottom, Richard Harshman, the company’s chief executive officer, told investors on a July conference call. The shares rallied 16 percent during the third quarter after tumbling 17 percent in the previous three months.

“The companies have lagged as commodity prices have come under more stress the last few years,” Eric Teal, who helps oversee $5 billion as the chief investment officer at First Citizens BancShares Inc. in Raleigh, North Carolina, said by phone. “The outlook is optimistic. The emerging markets will continue to produce high levels of GDP growth. Fundamentally, they look attractive.”

To contact the reporters on this story: Nick Taborek in New York at ntaborek@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net; Lu Wang in New York at lwang8@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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