Underground stocks for the gurus

Some of the world's best investors are keying in on natural-resource plays.

By John Reese Dec 14, 2011 5:01PM

Image: Coal miners (© Digital Vision/SuperStock)Some of the world's most successful investors have been bullish on natural-resource stocks recently as the world population continues to rise, global economies operate on non-renewable resources, and central banks inject huge sums into the financial system.

 

One is Jeremy Grantham of GMO, who has been high on resource stocks as longer-term investments for some time. "I like (personally) resources in the ground on a 10-year horizon," Grantham wrote in his recent third-quarter letter to clients. (He says he's "nibbling in very slowly", however, because he thinks such stocks could be vulnerable in the short term, thanks to "less bad" weather recently and a potential China slowdown.)


Grantham has a particular affinity for timber, saying in an earlier 2011 letter, "For those with a long horizon, I am sure well-managed forestry and farmland will outperform the average of all global assets."

 

Mark Mobius of Templeton Asset Management has also been high on commodities. He recently told Bloomberg News that some of his favorites include copper, palladium, nickel and platinum, citing strong demand from emerging market nations. And Carl Icahn has been making big news with his bid for Commercial Metals Company (CMC)

 

With inflation creeping higher this year -- the October Consumer Price Index figure was 3.5% above the year-ago level, the highest October gain in three years -- it may indeed be a good time to check out natural-resource stocks.


Of course, even if you're high on resource stocks in general, you don't want to load up on them indiscriminately. So I recently used my Guru Strategies -- each of which is based on the approach of a different investing great -- to find some of the most fundamentally sound resource stocks in the market. I found a number of intriguing picks. Here are some that are worth a good, long look. (Keep in mind that stocks like these will be very susceptible to concerns about the global economy in the short term, so you should view them as long-term plays.)

 

Cliffs Natural Resources Inc. (CLF): This Cleveland mining company is a major global iron ore producer and a significant producer of high- and low-volatile metallurgical coal. It has mines in North America and Australia, and a market cap of about $10 billion.

 

Cliffs gets strong interest from my Peter Lynch-inspired model. While the company had a rough 2009, it has rebounded strong in 2010 and 2011, and has a long-term earnings-per-share growth rate of 32.6% (I use an average of the three-, four-, and five-year growth rates to determine a long-term rate). That makes it a "fast-grower", according to this model -- Lynch's favorite type of investment. Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide Cliffs' 5.1 P/E ratio by that long-term growth rate, we get a P/E/G of 0.16. That easily falls into this model's best-case category (below 0.5).

 

Vale SA (VALE): A lot of mining stocks have taken a hit lately on global economic fears, and this Brazil-based firm is one of them. The second largest mining company in the world and the largest in the Americas, Vale is a major producer of iron ore and pellets and nickel, and is also involved in production of manganese and ferro-alloys, copper, coal, potash, fertilizers, cobalt, platinum, steel, and precious metals.

 

Vale ($119 billion market cap) gets strong interest from my Lynch-based model. It considers the firm a fast-grower thanks to its 20.1% long-term growth rate. Vale's shares trade for just 4.8 times earnings, which makes for a stellar 0.24 P/E/G. The firm's debt/equity ratio (31.4%) also comes in well below this model's 80% upper limit.

 

ArcelorMittal (MT): This Luxembourg-based steel and mining company has a presence in over 60 countries. In addition to its extensive steel operations, the firm is also the fourth-largest producer of iron ore in the world. Its shares have had a rough 2011, like many steel and mining companies, but my James O'Shaughnessy-based model thinks it's become a bargain.

 

ArcelorMittal has a $28 billion market cap, and has taken in more than $92 billion in sales over the past 12 months, and that size is part of why my O'Shaughnessy-based model likes the stock. In addition, it likes that ArcelorMittal is producing $4.46 in cash flow per share, more than 3 times the market mean, and that its shares come with a dividend yield of 4.3%.

 

Potash Corporation of Saskatchewan (POT): Grantham has talked a lot about potash being a critical but dwindling resource that is essential for food growth, which makes the companies that deal in it a good place to look for resource investments. This Canada-based firm ($34 billion market cap) is the world's largest fertilizer company, responsible for about 20% of global potash capacity.

 

My Lynch-based model likes PotashCorp, which has a 27.3% long-term growth rate and 0.45 P/E/G ratio. The firm's inventory/sales ratio has also been declining, which the Lynch model likes to see. Lynch found that a rising inventory/sales ratio was a bad sign, indicating a company's products aren't in demand. PotashCorp's inventory/sales ratio fell from 15.7% to 8.7% in the most recent year.

 

Reliance Steel & Aluminum (RS): One of the largest metals service center companies in the U.S., Reliance distributes over 100,000 metal products that range from stainless steel to aluminum to brass to copper and beyond. The Los Angeles-based firm ($3.6 billion market cap) has a network of more than 200 locations in 38 states and countries in Asia, Latin America, and Europe. It has posted some strong earnings numbers this year, and year-to-date its shares have performed far better than many other steel firms.

 

Reliance gets approval from the model I base on the writings of Benjamin Graham. Graham was an extremely conservative investor, and this approach requires a firm to have a current ratio (current assets/current liabilities) of at least 2.0, and more net current assets than long-term debt. Reliance's current ratio is 3.77, and it has $1.8 billion in net current assets vs. $1.5 billion in long-term debt.

 

Graham is known as the "Father of Value Investing", so valuation was, of course, important to him. The strategy I base on his writings looks at both the P/E ratio and price/book ratio. Reliance is trading for about 12.7 times three-year average earnings (a time period Graham looked at to ensure more recent earnings weren't anomalous) and 1.15 times book/value, which makes it sufficiently cheap to pass this strategy.

 

I'm long VALE, MT, and RS.

 

John Reese is founder and CEO of Validea Capital Management and Validea.com, a premium investment research site, and the author of "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".

 

 

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