Raw-materials companies and homebuilders haven't gotten very much love over the past couple of years. And for good reason, with new home construction still down from historical levels and raw-materials prices in even worse shape. That's led the market to avoid these sectors in recent years.
And while there's been good reason to avoid many raw-materials and homebuilding stocks, there are also opportunities. Three of our contributors think that's exactly the case with top-10 homebuilder Meritage Homes Corp. (MTH 2.97%), coal-mining partnership -- yes, you read that right -- Alliance Resource Partners, L.P. (ARLP -0.05%), and iron-ore specialist Cliffs Natural Resources Inc. (CLF -7.56%).
Image source: Getty Images.
If you're looking for a stock to invest in that the market could be overlooking now, keep reading to learn what our contributors have identified that makes these three stocks stand out.
This homebuilder is dirt cheap
Jason Hall (Meritage Homes Corp.): The homebuilding industry is terribly cyclical and in some ways still recovering from the Great Recession. Even after more than five years of steady growth in new-home construction, housing starts are still below historical averages:
US Housing Starts data by YCharts
At the same time, many homebuilders have struggled to find skilled construction workers, since much of the workforce moved on when the housing crash wiped out the job opportunities in the industry for years, and fewer young workers have entered the field. This situation has pushed up labor costs, and that's combined with higher land prices to create a margin squeeze across the industry:
MTH Gross Profit Margin (TTM) data by YCharts
And while it makes sense for the market to factor in reduced margin, it may have taken things too far, particularly with a high-quality company like Meritage. At recent prices, Meritage stock trades for 11 times trailing earnings, less than half the average S&P 500 stock sells for today.
Furthermore, the homebuilding industry is growing. And that trend looks set to continue, with unemployment at the lowest level in a decade and a half, wages showing growth, and millennials finally starting to buy homes in larger numbers. With a strategic focus on building more entry-level homes, Meritage is perfectly positioned for the continued recovery in new-home construction.
Put it all together, and now could be an excellent time to invest in this top homebuilder while the market is looking elsewhere.
Loving a hated commodity
Reuben Gregg Brewer (Alliance Resource Partners, L.P.): No one would blame you for overlooking Alliance Resource Partners. After all, it's a coal miner, and carbon-spewing coal is among the most unloved energy sources in the world. But this partnership's 8% yield should still be on your short list if you're an income investor, for a number of reasons.
First, while other coal miners were bleeding red ink or going belly-up during a deep coal downturn, Alliance remained soundly profitable. Second, despite the downturn, the conservatively run partnership counts debt at a modest 25% (or so) of its capital structure, giving it plenty of leeway to deal with further coal-market gyrations. Third, management hinted in the first-quarter earnings release that it might start to increase its distribution again. It cut the disbursement in 2016 to ensure access to capital markets, not because it needed to save cash, and a return to growth so soon would be further proof that it's among the best-run coal miners in the world.
All of that said, coal remains a deeply out-of-favor fuel option facing material structural headwinds, such as a shift toward natural gas in the United States. So Alliance is an income investment in a slowly dying industry, not a growth play. However, if income is what you're looking for, it could be a perfect fit for your portfolio. Indeed, it offers a high yield from a conservatively run partnership that has proved it can handle coal downturns that push others into bankruptcy court. That's impressive.
This infrastructure stock deserves your attention right now
Neha Chamaria (Cliffs Natural Resources Inc.): If you wondered why Cliffs Natural Resources has lost more than one-third of its value in the past three months, all you have to do is see this chart:
Iron Ore Spot Price (Any Origin) data by YCharts
As North America's largest manufacturer of iron ore pellets, Cliffs' fortunes pretty much hang on iron-ore prices, which can be volatile and unpredictable. Call it misfortune for being in a commodity business, but investors have clearly overlooked all that's brewing inside the company lately.
There's no denying that Cliffs is having a hard time, having recently reported a sharp plunge in first-quarter profits and downgraded its full-year earnings guidance. But aside from low iron-ore prices, which is something Cliffs can't control, the company also recorded one-time debt-extinguishment charges as part of its aggressive deleveraging efforts. Cliffs had brought its debt down to $1.6 billion from $2.5 billion as at the end of Q1 2016.
In fact, demand for iron-ore pellets, a key raw material for steel, remains strong as well, as seen in the 63% jump in Cliffs' U.S. pellet volumes in Q1. With President Trump just delivering another campaign-like speech in which he reiterated his plan to spend $1 trillion on rebuilding America's infrastructure. Cliffs could be one of the biggest beneficiaries when roads, dams, and highways are built and repaired, since it's a supplier to some of the largest steel manufacturers. Keep in mind that there's nothing concrete yet in terms of Trump's plans, but if you're optimistic about infrastructure under his presidency, now is the perfect opportunity to consider Cliffs Natural Resources.
