By Sam Stovall
Three entries on this week's are members of the S&P Materials sector index, which consists of 14 industries containing chemicals, metals, and paper and forest products companies. (The Materials sector represents 3.1% of the market value of the S&P Composite 1500 index.)
The three groups -- Aluminum, Diversified Metals & Mining, and Steel -- had 12-month price performances that were in the top 10% of all industries within the 1500. And each carries a favorable investment outlook from S&P analyst Leo Larkin. Here are his views on each:
Aluminum: Larkin's positive outlook for this group reflects his expectation for continued improvement in the industry's supply-demand fundamentals -- and a higher price for the metal. Following aluminum producers' rebound in 2003 from the depressed levels of the prior year, he sees an acceleration in sales and profits in 2004, reflecting higher aluminum prices and lower costs. He projects an average aluminum price of 78 cents a pound in 2004, vs. 65 cents in 2003.
While Larkin believes the aluminum industry still suffers from excess capacity, he thinks continuing consolidation will help ease overproduction. Also, improved economic conditions in Russia and China should ultimately result in increased internal consumption within -- and lower exports from -- those countries, thereby reducing a worldwide glut. Finally, it appears that curtailment of some production in the Pacific Northwest may become permanent, also alleviating some of the global oversupply.
Copper/Diversified: The S&P Diversified Metals & Mining subindex (where copper companies dominate) is projected to outperform the market in 2004, as it did in 2003. After peaking in 1995 at $1.35 per pound, the average price of copper dropped steadily, albeit irregularly, through 2002, mostly as a result of excess global production relative to demand. But prices recovered smartly in 2003, and the prospects for rising copper prices in 2004 are bright, in Larkin's view, based on S&P's expectation of increased demand for the metal arising from anticipated greater infrastructure spending in Russia and China.
An additional positive factor is the curtailment of supply in recent years in response to depressed prices. For 2004, S&P believes copper will average at least $1.10 a pound, vs. 2003's average of 81 cents.
Steel: In 2003, the S&P Steel subindex was also a market outperformer. Larkin projects solid improvement in industry operating performance in 2004, and he believes the group will again outperform the 1500. Although steel imports may rebound in 2004 with the removal of U.S. tariffs on December 4, 2003, Larkin believes the impact will be minimal. To the extent that imports put any downward pressure on prices, he notes, they'll force the shutdown of marginal capacity operated by steel concerns under Chapter 11 bankruptcy protection. Thus, he thinks a rise in imports will ultimately reduce domestic supply, limiting the impact on prices and profits.
Based on S&P's forecast of 4.5% real GDP growth in 2004, vs. the 3.2% estimated for 2003, sales and operating results should improve for steelmakers. Other positive factors in 2004 will likely be a forecasted rise in North American auto production and expected continued weakening of the U.S. dollar relative to most currencies. Also, nearly every domestic steel producer has instituted a raw-material surcharge to offset sharply rising costs for production inputs such as scrap, iron ore, and coke. The surcharges should lift margins and help the industry return to profitability in 2004.
So there you have it. According to Larkin, the price performances of these metal-based industries are likely to remain firm in the year ahead. Rebounding global economies have helped metals prices recover from dramatic price declines of a few years ago and are expected to continue enhancing the bottom lines of many metals mining companies during 2004.
Larkin's top picks in the groups mentioned above include Alcoa (AA ) and Alcan (AL ), both ranked 4 STARS (accumulate), in aluminum; Phelps Dodge (PD ), also ranked 4 STARS, in copper; and in steel, Nucor (NUE ), which carries a 5-STARS (buy) opinion.
Industry Momentum List Update
For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of February 13, 2004.
* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).
Stovall is chief investment strategist for Standard & Poor's