April 25, 2016
MetalMiner Editor Jeff Yoders recently had a chance to discuss the broad commodities rally, individual metals markets and other related news withMorningstar Senior Equity Research Analyst Andrew Lane, (here he is talking about Alcoa, Inc.on CNBC). The Chicago-based, independent investment research firm recently released its Basic Materials Observer.
Morningstar warns that basic materials stocks look somewhat overvalued, with the average company under its coverage trading at a 12% premium to their analysts’ fair value estimate. That’s not to say that Morningstar’s analysts don’t see pockets of significantly undervalued companies in the sector. Key takeaways:
Despite the recent rally in some commodity prices, Morningstar analysts’ outlook for commodities related to Chinese fixed-asset investment remains negative.
Price outlooks are relatively better for commodities related to the Chinese consumer. However, Morningstar analysts would preach caution on the recent safe-haven gold rally.
With faltering Chinese growth likely to wreak havoc on investment-oriented commodities, the analysts look to U.S. housing as a pocket of opportunity. Morningstar analysts believe housing starts will be driven higher during 2016.
In discussing the ongoing steel overcapacity issue, Lane said that any real recovery in demand in the Chinese economy is still far away, hindering the demand outlook from what was once the main driver for worldwide production.
“Any real recovery can’t come until past 2020 which is as far our long-term outlooks go,” he said. “The funding for these loss-making facilities, it has to run out at some time. It remains to be seen how far the local governments in China can kick the can down the road by keeping their local and provincial capacity open with access to this (loan) capital. It’s a game that can’t go on forever but… we tend to think that they can maintain current production levels for a lot longer than most people give them credit for.”
Morningstar is, like MetalMiner, taking a wait-and-see approach to the recent rally seen in global steel prices.
“I cover steel and we’ve seen a little bit of a rally in Q1 in steel, and a smaller one in aluminum, but mostly in steel,” Lane said. “Certainly, relative to our peers, we take a long-term view. We’re a lot more interested in predicting what an industry and a company’s earnings will look like five years out rather than what they will look like the next quarter or the quarter after that.”
For that reason, Lane remains skeptical of the recent price surge, especially considering the effects that trade cases have had. Aluminum has similar fundamental problems.
“All of the main catalysts being listed can be very fleeting or near-term in nature, particularly the impact of trade cases on domestic volumes over the next two quarters, or the impacts of trade cases on prices for the next few quarters,” he said.
“Even if the near-term outlook is a little rosier than it has been in some time, the overarching fundamentals of steel and aluminum are still quite negative,” he explained. “There doesn’t seem to be a solution in place for the key issues facing either market. Structural overcapacity is likely to remain in place for both commodities. Steel’s recent rally has been much more driven by supply side economics than demand side economics which gives me less conviction that the rally will be sustainable.”
Both MetalMiner and Morningstar are monitoring the lucrative automotive market and how it impacts several different metals suppliers. The release of the aluminum-bodied Ford F-150 was a breakthrough moment for aluminum in automotive, but the impact is still a small one and steel is still winning the car wars.
“A lot of other automakers are still taking a wait-and-see approach to how consumers adopt that aluminum-bodied model,” Lane said. “It seems that sales have been going fairly well and there have been no major problems so far. Other automakers have been a little bit slower than we expected since Ford took the jump.”
Lane noted that other automakers are substituting certain parts of the car,such as the hood, to lighten the weight of their cars and trucks and come into compliance with federal Corporate Average Fuel Economy standards, but he also noted that it would take a handful of other automakers making full-body substitutions to move the needle for aluminum in automotive.
“Certainly, aluminum has taken some overall share in the automotive space,” he said. “But you have to remember that aluminum is also is losing a bit of share in aerospace to titanium and other specialty metals or even carbon fiber. Some of those automotive gains are being offset by the losses in aerospace.”
As U.S. aluminum production has declined rapidly over the last few years, Alcoa, Inc. has taken capacity offline and cut itself in two with one half devoted to shifting toward specialty, high-value metals. Lane said this is largely a function of management trying to escape the aluminum commodities cycle.
“They have spent roughly $4.5 billion on acquisitions to gain exposure to alternative materials, such as high-value alloys, titanium, titanium alloys, nickel-based alloys and super alloys, these are truly specialty products,” he said.
“Alcoa clearly thinks that they will have more pricing power with those product types than they have with aluminum. That’s not, necessarily, a negative for aluminum but, rather, an instance of a company trying to control its own prospects, rather than be subject to a commodity cycle.”
Another company that Lane covers is Allegheny Technologies, Inc., and it also attempting a similar specialty product conversion albeit as one company, though, rather than the two that Alcoa will splint into.
“They (ATI) already had expertise in commodity-grade stainless as well as high-value, specialty materials for aerospace,” Lane said. “Both companies have shed a great deal of that less-attractive capacity and have focused their efforts on downstream, value-added products. ATI is one of our favorite picks right now. I cover 19, steel, aluminum and specialty stocks and only 3 of them are trading below what I think their fair value should be. We see it as materially undervalued.”