Love it or hate it, there's no denying Goldman is a force to be reckoned with. When these guys predicted that oil would surge to $100 and beyond back in 2006, many Fools laughed. The laughing stopped when oil proceeded to do just that. And when Goldman followed up its $100 prediction with a call for $200 oil just two years later, not only did no one laugh -- investors actually bid up oil futures, helping Goldman to fulfill its own prophecy. (Almost.)
For good reasons or ill, this banker's opinions move markets -- so even if you don't agree with Goldman, it's worth keeping an eye on what it's up to.
A mind like a steel trap
On Monday, the Institute for Supply Management reported December numbers showing a surprising resurgence in American manufacturing. U.S. industry grew at its fastest pace in three years last month, resulting in a "purchasing managers index" rating of 55.9. (Hint: Anything over 50 means that manufacturing is growing.)
Say what you will about Goldman, but one thing's for certain: These guys have an ironclad grasp of the obvious. No sooner had the ISM number made headlines at the Wall Street Journal Tuesday -- front page, first article, "above-the-fold" -- than Goldman's bankers got busy issuing upgrades. Across the length and breadth of the U.S. manufacturing sector, the verdicts came down:
One word: plastics
Or another: steel
Likewise in the steel sector. For reasons similar to the chemicals upgrades, Goldman took a positive stance on the steelmakers this week, making bullish noises about mini-mill operators Nucor
Of course, higher multiples on profits won't mean a whole lot until these stocks start earning profits. Right now, each of Goldman's three named picks in the steel sector (actually, make that four -- Goldman also likes AK Steel) are operating at a loss, and sporting trailing P/E ratios of "N/A." Most analysts on Wall Street expect that to change in the New Year, however, and these companies are now trading at valuations ranging from the entirely reasonable (a 15 times forward multiple on Steel Dynamics) to the seemingly absurd (64 times 2010 earnings for U.S. Steel -- holy molybdenum, Batman!).
A Foolish suggestion
So how should a Fool invest in response to Goldman's upgrades today? Personally, I'd suggest hedging your bets. Maybe the ISM report does indeed portend a rally in the industrial sector generally, and the steel sector in particular. But whether the new year holds good things or bad for the industry overall, I think it's safe to say that the strongest companies will do best in good times, and least-worse in bad.
That being the case, my advice would be to toss Goldman's top pick overboard right from the start. Among the four steelmakers named above, U.S. Steel sports a balance sheet that contains the most debt -- nearly $3.4 billion -- versus $1.5 billion cash. Worse still, it's currently burning through what cash it has, with free cash flow running negative to the tune of $267 million over the last 12 months.
In contrast, Goldman's recommendations of both Nucor and Steel Dynamics make a lot of sense to me. The former generated $500 million in cash profit last year, giving it a very reasonable enterprise value-to-free cash flow ratio in addition to its cheapest-of-the-bunch P/E ratio. And the steel case for Nucor looks even shinier. Here we've got a company with:
- Only $1 billion in net debt to its name,
- An enterprise value-to-free cash flow ratio of just 10,
- Long-term growth expectations of 15% per year,
- And last but not least, a healthy 3% dividend to tide you over while you wait for Goldman's promised recovery.
Yep, the more I look at it, the more I'm convinced. If it's profits potential you seek, Nucor's got more.