Steel: Don't Think Rust, Think Cheap

 | Dec 08, 2011 | 11:00 AM EST  | Comments
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A character in the 1960s classic The Graduate famously proclaimed that plastics were the wave of the future. More recently, observers say the future is the Internet.

But what about steel? Is it old-fashioned enough now to be lumped in with buggy whips and black-and-white TVs?

To find out, let's look at what the smart money says. My whole approach to investing is to apply the investment strategies of 10 or so of Wall Street's greats to my investment decisions and those of my readers and clients. But the universe of smart investors is not limited to those I regularly follow. You have seen me report occasionally on what other strategists are doing and how their picks match the strategies I use.

A smart picker of a different sort is Carl Icahn. "Activist investor" is how he is often portrayed, though in the past he was sometimes thought of as a "greenmail" player (someone who threatened to take over a company with the hope management would handsomely pay him to go away). He has been very successful, financially, with a reported net worth in excess of $12 billion.

Icahn is worth watching, which is why I paid attention to his latest foray into activist investing when he announced an unsolicited bid to take over Commercial Metals Co. (CMC), a scrap-metal processor. This is essentially a steel company, which for many recalls the American rust belt. But just as Warren Buffett surprised many a couple of years ago by spending tens of billions of dollars to purchase another rust belt icon, railroad Burlington Northern Santa Fe, Icahn may also be on to something by wanting to jump into the steel industry.

Steel production is strong, though there is some question of how well steel demand will hold up, given the uncertainty facing the world economy. The market reflects this by knocking down the price of steel stocks. POSCO (PKX), a major South Korean steel producer, recently traded at about $87 per share, which is toward the lower end of its 52-week range of $70.47 to $118. The same is true for Gerdau (GGB), a big Brazilian producer, whose stock is about $8, also towards the lower end of its 52-week range of $6.60 to $15.11.

What does Icahn see? I believe he sees undervalued stocks that have had the wind knocked out of them, so this is a good time to pay attention to them.

I found two steel companies whose stocks earn great grades from my guru strategies. If you have a steel spine and are willing to go against the tide, these two are worth considering.

Ternium (TX) is a steel conglomerate that operates primarily in Mexico and Argentina. Its stock is trading at about $18, while its 52-week range is $15.31 to $43.85. My Peter Lynch-based strategy likes Ternium because its price-to-earnings ratio is 7.37 and its growth rate is 29.9% (based on the average of its three- and four-year historical growth rates), giving it a price/earnings/growth rate of 0.25. (PEG is a measure of how much an investor is paying for growth -- up to 1.0 is acceptable, and 0.25 is very low and very good.)

My Kenneth Fisher strategy considers TX a "super stock" because it has a favorable price-to-sales ratio, acceptable debt level, a strong long-term EPS growth rate, positive free cash per share and a solid three-year average net profit margin of 10.45%. This company's stock may be a bit battered, but the company is doing well.

ArcelorMittal (MT) is the world's largest steel maker. Its stock is about $19 and its 52-week range is $14.77 to $38.88. It earns a first-place ribbon from my James P. O'Shaughnessy strategy, which likes ArcelorMittal's large market cap of $30 billion, strong cash flow per share of $1.39, large number of shares outstanding (612 million), and huge sales of $92 billion.

As a final step, the strategy selects from among the stocks that passed previous tests, with the top 50 based on dividend yield. ArcelorMittal's 3.89% dividend yield places it in this rarefied group.

Steel. Don't think rust, think cheap. Icahn thinks there might be money in this essential metal, and I think he could be right.

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