Why Commodity Producers Will Produce the Goods in 2012

While the equity market gets high off the fumes of Alcoa's optimistic outlook, another industrial bellwether is still reeling from the impact of some noteworthy market softness during its fiscal first quarter of 2012.

Schnitzer Steel (Nasdaq: SCHN  ) was looking lean and mean last summer when the metal scrapper pumped iron to achieve earnings of $1.17 per share. Fast-forward a couple of quarters, and the company is in serious need of a workout session with Hans and Franz to pump it back into shape. Schnitzer hoisted first-quarter earnings of just $0.25 per share, which actually did strike the high end of revised guidance delivered before the holidays.

The primary culprit here is a nemesis we've seen Schnitzer and its rivals battle before: margin compression. As steelmakers worldwide dialed back their raw-material purchases in the face of considerable macroeconomic uncertainty late last year, prices for scrap iron fell far faster than Schnitzer's average inventory cost. The inherent vulnerability of operating margins to near-term price volatility is precisely why I personally tend to steer clear of the metal scrappers entirely. I prefer to retain my focus at the top of the production chain, where miners like Cliffs Natural Resources can only have their margins squeezed from one end rather than two.

But conceding my own preference for the miners of raw material does not mean the scrappy steel makers can be ignored. Quite to the contrary, my longtime favorite stock in the steel sector has cracked some serious thunder lately with a noteworthy surge accompanied by a powerful dividend kicker! Nucor (NYSE: NUE  ) has advanced a remarkable 38% from its lowest close in 2011 just over three months ago, and continues to entice investors with a 3.55% dividend yield. Behind that surge lies some "real demand improvement" that Nucor conveyed last month with respect to automotive, heavy equipment, energy, and general manufacturing end markets.

Throughout the gut-wrenching collapse in commodity stocks that characterized the latter portion of 2011, I remained steadfast in my view that demand-related concerns would prove a near-term blip within the longer-term trend for growing global demand. So when the investment world was selling shares of Peabody Energy (NYSE: BTU  ) in a sustained and indiscriminate rush for the exits, this Fool was happy to scoop up the bargain. Accordingly, Peabody Energy earned my selection as the top energy stock for 2012.

Within its latest quarterly release, Schnitzer Steel echoed my bullish long-term commodity outlook by stating: "Despite the short-term volatility, all indications are that long-term demand fundamentals in our export markets remain strong, primarily due to expectations for further growth and increasing urbanization in developing economies, and increasing usage of recycled metals globally." Because bellwethers like Alcoa, Nucor, Schnitzer, and others continue to corroborate my view that industrial commodity demand is likely to remain far more robust that last year's equity market dynamics would seem to suggest, I continue to view the shares of quality commodity producers as the most attractive equity sector for 2012.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Peabody Energy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (16)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2012, at 1:03 PM, SN3165 wrote:

    Sinch I know you like Peabody but what do you think of Arch Coal at these prices ($14) ?

  • Report this Comment On January 14, 2012, at 4:45 AM, TempoAllegro wrote:

    Hey Sinch:

    If you had to choose between the following commodities, which would you choose, or perhaps, how much would you allocate to them?

    Coal, Gold, Silver, Copper, Iron, Rare earths, Fertilizers, Oil?

    Do you have a position on service providers, such as rail companies, oil service companies, or luxury goods? (Examples: CNI, NOV, COH or LVMUY?)

    Is BTU the best in the coal area, or would you rather go with a big fella such as BHP?

  • Report this Comment On January 16, 2012, at 12:45 PM, XMFSinchiruna wrote:

    SN,

    I think the entire coal patch is riddled with deep value at the moment, and with a yield over 3% now, a strong investment case can be made for ACI as well.

    mungermaniac,

    I am most heavily weighted in the first 4 of your list, and my own personal sequencing of that list in terms of relative allocation is silver, gold, coal, copper.

    I do not presently own any of the service providers, though within the group the exploration drilling contractors like Major Drilling have piqued my interest. The rails are solid long-term investments in my view, and I have favored Canadian National (CNI).

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