All week, most of the talk that has dominated the markets has been all about tariffs and a looming trade war. And even though they’ve shown to be less harsh and unilateral as the President originally made them out to be, the fact still remains that tariffs on steel and aluminum imports, if extended into a long-term period of time, should cause ripples through multiple segments of the U.S. economy.
I think one of the natural questions any investor should be asking isn’t just about what the economic and market reaction to tariff implementation is going to be. It’s easy to get caught up in the hand-wringing and finger-pointing game, which in the absence of actual, useful facts, is what most popular media seems to be focusing on right now. It’s important from an objective standpoint, however to remember that market opportunity exists in all kinds of circumstances.
The vast majority of market sectors have seen some pretty wild swings in volatility this week, and for the most part are showing indications of short-term weakness. From the standpoint of value-oriented investing, that’s really not a terrible thing, since valuations are dropping to levels that make a lot of the stocks, across a pretty wide spectrum of sectors and industries more and more attractive. That should increase the number of good opportunities out there, and even if you’re taking a conservative, cautious approach under current market conditions, having more options to think about is much better than just a few.
One segment of the economy that should naturally stand to gain from tariffs on steel and aluminum imports comes, not surprisingly, from U.S. producers of those basic materials. Ironically, the market has beaten up most of those stocks over the last couple of days since we saw the formalized, softer-than-expected form of the proposed tariffs. Canada and Mexico were given exemptions from tariffs for the time being, which softens the blow anticipated by Trump’s original bluster quite a bit. Canada is the top exporter of steel and aluminum to the U.S., and Mexico is the fourth-largest exporter of aluminum. Even so, these tariffs are going after exporters from the European Union and all of Asia.
Overall, the U.S. imports about a third of its requirements for steel, but nearly 90% of aluminum. Even with the “watered down” version of tariffs moving forward, it seems logical that U.S. producers should benefit from tighter restrictions on imports. U.S. Steel, for example, seems to be running with the news; the announced yesterday that they plan to call back 500 workers to restart steelmaking and blast furnace facilities at a plant in Granite City, Illinois, signaling what seems to be a clear expectation of increasing domestic demand.
Who are the U.S. companies, then, that should see healthy gains from steel and aluminum tariffs, and that could present the best opportunities in the short to medium term? I’ve run quickly through a list of some of the major steel and aluminum producers based in the United States and filtered them through a number of fundamental and value criteria. From a value standpoint, right now there is little argument to be made for any of them as being undervalued to any degree; they are all trading at or near to historical highs, or at the very least are above their historical Price/Earnings and Price/Book ratios. Even so, I think there could be some good opportunities from this segment in the near future, and in most cases a good argument can be made that, while not undervalued, they are still a fair distance away from being overvalued. The fundamentals for each of the stocks highlighted below are quite good. By my evaluation, these are the five strongest U.S. companies in the steel and aluminum industries, and that you should be paying attention to right now.
Alcoa Corp (AA)
Easily the largest, and most recognizable aluminum producer in the U.S., AA is a company with an $8.8 billion market cap, with great fundamentals driving their business. Over the last nine years, the stock has periodically cycled from long-term trend lows below $20 to trend highs just a little above $40. As of this writing the stock is above $48, but coming off of a recent pivot high at about $57. So where is the opportunity? Before the financial crisis of 2008, the stock frequently saw trend highs in the $90 to $100 range. If they work as the Trump administration clearly intends, tighter aluminum imports should give companies like AA a clear path to more growth, which in the long-term could provide the impetus needed to drive the stock back to its 2000-2008 highs.
- Dividend: AA doesn’t offer a dividend.
- Free Cash Flow: this measurement is the most impressive among the companies highlighted here, with a Free Cash Flow Yield of 11.9%. The company holds a healthy position of cash and liquid assets that gives them plenty of flexibility to service their current debt levels and make strategic moves to expand their business.
- Debt/Equity: AA’s debt/equity ratio is .20, and among the lowest in the industry. The company’s balance sheet also indicates that liquid assets are sufficient to almost completely satisfy their long-term debt burden.
- Return on Equity/Return on Assets: Neither of these measurements are as high as we would prefer to see, but are also not cause for concern. ROE is 7.20 and ROA is 3.28. These numbers also improved in every quarter of 2017 and should continue to do so for the foreseeable future.
Nucor Corp (NUE)
NUE is by far the largest U.S. steel producer, with a market cap of more than $21 billion. Among steel and aluminum producers, they also have arguably the strongest overall fundamental profile. They are currently trading nearly at par with their historical Price/Earnings and Price/Book ratios, but have been following a solid upward trend dating back to the beginning of 2016.
- Dividend: at its current price, NUE’s dividend offers a current yield of about 2.19%, which is inline with the industry average and a little above the S&P 500 average.
- Free Cash Flow: this measurement doesn’t appear very impressive, with a Free Cash Flow Yield of only 2.8%. More importantly, the company holds a healthy position of cash and liquid assets that gives them plenty of flexibility to service their current debt levels and make strategic moves to expand their business.
- Debt/Equity: NUE’s debt/equity ratio is .36. The company’s balance sheet also indicates that operating profits are more than sufficient to service their debt.
- Return on Equity/Return on Assets: Both of these measurements are healthy. ROE is 13.03 and ROA is 7.11.
Kaiser Aluminum Corp (KALU)
KALU isn’t the largest U.S. aluminum producer; in fact, with a market cap of only $1.7 billion, this is a much smaller company than Alcoa Corp (AA) with a cap of about $8.7 billion. They are, however the only U.S. aluminum company that pays a dividend.
- Dividend: at its current price, KALU’s dividend offers a current yield of about 2.11%, which is roughly in-line with the industry average but a little above the average of the S&P 500.
- Free Cash Flow: like most steel and aluminum stocks, this measurement at first glance looks less than impressive, with a free cash flow yield of only about 3.7%. It is also true that KALU’s free cash flow dropped by almost 50% from the third to fourth quarters of 2017; however the company does hold very healthy cash and liquid assets that translates to a cash yield of about 13.3%.
- Debt/Equity: KALU’s debt/equity ratio is .5, which is generally a pretty healthy number. The company’s balance sheet indicates that their cash and liquid assets are more than adequate to service the debt they have.
- Return on Equity/Return on Assets: These fundamental measurements are healthy. ROE is 11.35 and ROA is 6.27.
U.S. Steel (X)
U.S. Steel isn’t nearly as big as Nucor Corp, with a market cap of about $7.8 billion, but it is one of the most visible steel producers in the U.S., with the most easily identifiable name. Like NUE, X is trading at all-time highs, and is also significantly above its historical valuation ranges. They’ve been one of the most vocal supporters of hard-line tariffs in the past week.
- Dividend: at its current price, X dividend offers a current yield of only about .44%; keep in mind, however that few companies in the industry pay a dividend at all.
- Free Cash Flow: this measurement is better than either what we saw with NUE or KALU, with a Free Cash Flow Yield of about 5%, but it is still a little below my normal preference of 10% or higher. Their strong position of cash and liquid assets, however offers a cash yield of about 19%, which is very attractive. It is also worth noting that their cash position has also improved steadily since the first quarter of 2016.
- Debt/Equity: the debt/equity ratio for X is .81, a little higher than we saw for NUE or KALU, but still generally manageable. The company’s balance sheets indicates operating profits and liquid assets are more than adequate to service their debt.
- Return on Equity/Return on Assets: ROE is healthy, at 12.56, while ROA is a little low at 3.54.
Century Aluminum Company (CENX)
We have all three of the biggest aluminum producers in the U.S. on our list, not only because they each have an overall solid fundamental profile, but also because of the two segments, aluminum has the most room for growth. Even if the U.S. continues to import most of its aluminum from Canada and Mexico, the truth is that anything that moves the needle higher for reliance on local domestic producers should translate to big opportunity for these companies. CENX is about as big as KALU, with a $1.7 billion market cap.
- Dividend: CENX does not pay a dividend.
- Free Cash Flow: this measurement is low, with a Free Cash Flow Yield of just a little above 2%. That low number is offset by the fact that they hold nearly as much in cash and liquid assets as they do in debt.Their strong position of cash and liquid assets, however offers a cash yield of almost 10%. It is also worth noting that their cash position has also improved steadily since the first quarter of 2016.
- Debt/Equity: the debt/equity ratio for X is .30, which is quite manageable. The company’s balance sheets indicates operating profits and liquid assets are more than adequate to service their debt.
- Return on Equity/Return on Assets: ROE is 4.52, while ROA is 2.26. While these numbers are unremarkable, it should be noted that these numbers had been deeply negative beginning in the middle of 2016, but have improved in each quarter since that point. They finally turned positive in the fourth quarter of 2017. That marks a fundamental turnaround that should continue into the foreseeable future.