Industrial Metals Stock Outlook - November 2017

Improved Performance

Year-to-date, the Mining-Iron and Mining-Non Ferrous industries have recorded a respective rise of 32.9% and 24.9%. The industries have outperformed both the Basic Material sector’s increase of 19.3% and the S&P 500’s corresponding advance of 16.9%.

Attractive on the Valuation Front

Valuation looks attractive for both the industries going by the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) multiple, a preferred valuation metric for cyclical industries like iron and non-ferrous industries. The mining-iron industry has a trailing 12-month EV/EBITDA multiple of 4.27 and the mining-ferrous industry has a trailing 12-month EV/EBITDA multiple of 7.93.

Both these compare favorably with the broader Basic Materials Sector’s EV/EBITDA multiple of 10.39 and S&P 500 EV/EBITDA multiple of 11.35. The industry’s lower-than-market positioning calls for more upside.

Q3 Earnings Scorecard, Projections

The basic materials sector logged a 2.6% increase in third-quarter earnings. The earnings growth graph for the sector will pick up fourth quarter onward. Earnings growth will be 29.9% in fourth-quarter 2017, 18.3% in first-quarter 2018, 13.7% in the second and 9.7% in third-quarter 2018.

What’s in Store?

Iron: Global steel production rose 5.6% year over year during the first nine months of 2017 to 1267 million tons. The World Steel Association forecasts global steel demand to go up 7% in 2017 and 1.6% in 2018. China’s steel demand is expected to increase by 3.0% in 2017. This will boost demand for iron ore.

The supply surge resulting from Vale S.A. (VALE - Free Report) S11D, Rio Tinto plc’s (RIO  - Free Report) Pilbara projects, and BHP Billiton Limited’s projects will create a surplus in the already well-supplied iron ore market. However, China is planning to cut steel capacity to reduce pollution in the country. By 2020, the government aims to trim 100-150 million tons of steel capacity. Sustained capacity rationalization could lead to higher steel prices, which in turn should support iron ore prices.

Aluminum: Global aluminum markets are expected to be in a deficit in 2017. China’s demand, which accounts for about half of total demand, is likely to be sustained by the building and construction sector as well as the automotive and railway sectors. With the country deciding to cut capacity, supply will also be checked.

Moreover, in North America, demand should remain robust, mainly due to the building and construction, automotive, packaging and airline industries. India appears promising given its current low levels of aluminum consumption and high urban population growth.

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