After the Fall: A Value Choice in Base Metals and Steel (RIO, VALE, BHP, X, NUE, STLD, MT, FCX, SCCO, AA)

The single most important word in world markets for base metals and steel is “China.” With the slow-motion economic recovery in the global economy, the expected 8% or so growth in Chinese GDP will have to float the boats of many mining and steel-making companies this year.

A recent spate of iron ore delivery cancellations in China is being carefully watched for signs of near- and medium-term demand. If the shipments are replaced by new orders at lower prices, that signals at least a neutral market. If the shipments are not replaced by new orders, that indicates even weaker demand from China. Iron ore producers like Rio Tinto plc (NYSE: RIO), Vale S.A. (NYSE: VALE), and BHP Billiton Ltd. (NYSE: BHP) are all reasonably upbeat on Chinese demand for iron ore.

Steel makers are in a similar position, which production outstripping demand, cancelled orders, and the expectation of a price war on the horizon. United States Steel Corp. (NYSE: X), Nucor Corp. (NYSE: NUE), Steel Dynamics Inc. (NASDAQ: STLD), and ArcelorMittal (NYSE: MT) face poor overall demand and are making only small capital investments in production facilities. If there is some good news for non-Chinese steel makers it is that price differentials for China’s steel are closing slightly as higher wage costs and lower steel prices are affecting Chinese margins.

Among base metal miners including copper producers like Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) and Southern Copper Corp. (NYSE: SCCO) and aluminum maker Alcoa Inc. (NYSE: AA) pricing is just as tight and depend just as much on improving demand from China. The implied demand for copper for the rest of this year was down -6.8% month-over-month in April. Aluminum demand is expected to grow over the next five years, again mostly from China. But the biggest trend in aluminum is consolidation, never a sign that the market is getting stronger.

Our look at these companies is focused on trying to figure out whether or not low share prices are an opportunity to grab some value or whether current prices are a value trap. What seems most likely is that expectations of a near-term turnaround in share prices are probably wishful thinking, but, as with all commodities, the cycle will return to higher prices. The only question is when.

Rio Tinto plc (NYSE: RIO) traded at $45.76 and has a market value of around $85 billion. The consensus target price from Thomson Reuters is $85.68 and the 52-week range is $40.50-$74.00. Rio has a dividend yield of 4.2%. The implied upside to the consensus target is 87%, and we note that the target is above the 52-week high.

Vale S.A. (NYSE: VALE) traded at $18.83 and has a market value of around $97 billion. The consensus target price from Thomson Reuters is $29.11 and the 52-week range is $17.62-$33.74. Vale has a dividend yield of 6.3%. The implied upside to the consensus target is 55%, and we note that the target is below the 52-week high.

BHP Billiton Ltd. (NYSE: BHP) traded at $63.96 and has a market value of around $171 billion. The consensus target price from Thomson Reuters is $65.39 and the 52-week range is $61.22-$97.37. BHP has a dividend yield of 3.6%. The implied upside to the consensus target is 2%, and we note that the target is well below the 52-week high.

United States Steel Corp. (NYSE: X) traded at $22.19 and has a market value of around $3 billion. The consensus target price from Thomson Reuters is $36.00 and the 52-week range is $18.85-$47.33. US Steel has a dividend yield of 0.9%. The implied upside to the consensus target is 62%, and we note again that the target is below the 52-week high.

Nucor Corp. (NYSE: NUE) traded at $36.41 and has a market value of around $12 billion. The consensus target price from Thomson Reuters is $47.63 and the 52-week range is $29.82-$45.75. Nucor has a dividend yield of 4%. The implied upside to the consensus target is 31%, and we note again that the target is above the 52-week high.

Steel Dynamics Inc. (NASDAQ: STLD) traded at $10.73 and has a market value of around $2 billion. The consensus target price from Thomson Reuters is $17.25 and the 52-week range is $8.78-$17.33. Steel Dynamics has a dividend yield of 3.8%. The implied upside to the consensus target is 61%, and we note that the target is within pennies of the 52-week high.

ArcelorMittal (NYSE: MT) traded at $14.80 and has a market value of around $23 billion. The consensus target price from Thomson Reuters is $26.97 and the 52-week range is $13.96-$35.31. ArcelorMittal has a dividend yield of 4.5%. The implied upside to the consensus target is 82%, and we note that the target is well below the 52-week high.

Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) traded at $33.15 and has a market value of around $32 billion. The consensus target price from Thomson Reuters is $52.89 and the 52-week range is $28.85-$56.78. Freeport-McMoRan has a dividend yield of 3.9%. The implied upside to the consensus target is 60%, and we note that the target is below the 52-week high.

Southern Copper Corp. (NYSE: SCCO) traded at $29.26 and has a market value of around $25 billion. The consensus target price from Thomson Reuters is $36.51 and the 52-week range is $22.58-$37.27. Southern Copper has a dividend yield of 7.4%. The implied upside to the consensus target is 25%, and we note that the target is below the 52-week high.

Alcoa Inc. (NYSE: AA) traded at $8.76 and has a market value of around $9 billion. The consensus target price from Thomson Reuters is $11.79 and the 52-week range is $8.31-$16.83. Alcoa has a dividend yield of 1.4%. The implied upside to the consensus target is 35%, and we note that the target is well below the 52-week high.

For comparison, the iPath DJ-UBS Copper Total Return Sub-Index ETN (AMEX: JJC) is up 0.3% today at $44.08 in a 52-week range of $38.99-$59.06. The Powershares DB Base Metals ETF (AMEX: DBB) is up 0.6% today at $18.68 in a 52-week range of $17.82-$25.23.

Among the iron ore miners, Rio’s implied gain of 87% is largely the result of a 12-month share price drop of -35%. The target price is astronomical by just about any measure and the company’s pullback on capital spending does not signal rapid new growth. Of the copper miners, Freeport, with its significant gold production, might expect more upside than Southern Copper. Alcoa potential upside is based almost entirely on a crumbling share price and low expectations.

As for the steel makers, the market appears on the brink of being ruled by low-cost producers, and none of these four really falls into that category. While implied gains would not be unreasonable in a reasonable economic world, today’s global economy is anything but reasonable.

The single best choice here appears to be Vale. Its high dividend yield of 6.3% makes up for a lot of sins. Yes, its target price is below its 52-week high and a lot depends on what happens in the Chinese market for iron ore. Still, BHP Billiton has no significant potential upside and Rio’s potential is most the result of a tumbling share price, the steel makers aren’t going to recover soon, the copper miners are even more dependent on China than the iron ore miners, and nobody loves aluminum.

Paul Ausick