By: Jeff Yastine — April 30, 2021
The Steel Sector is #1 - Here's How to Play It
Years ago I remember watching Warren Buffett and his sidekick Charlie Munger from the press seating area at a Berkshire Hathaway annual meeting.
Buffett, of course, commanded most of the attention. Munger, vice-chairman of the company, prefered to play the role of the mostly-silent curmudgeon.
But his insights about investing are no less noteworthy. One theme Munger goes back to on a regular basis in his public statements - that new, clever stock ideas aren’t necessarily the path to riches.
“It is remarkable,” he told CNBC a while back “how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
Those words come to mind with a group of stocks that have ripped higher in past months… steel stocks.
The SPDR S&P Metals & Mining ETF (XME) is a good example. It’s up 77% in the last 6 months.
The steel sector makes up fully 45% if the fund’s holdings.
Yes, steel stocks are boring. Yet in terms of being “consistently not stupid” you can’t ask for a better play, in my opinion.
Global steel demand fell nearly 13% last year, thanks to the pandemic. Now we’re on the flipside of that situation.
The boom isn’t going to end anytime soon.
The World Steel Association recently revised it's estimates, and expects global demand to grow by 5.8% this year, reaching nearly 1.9 billion metric tons. In 2022, they expect an additional 2.7% rise.
“In coming years,” said the organization’s chief economist Saeed Ghumran Al Remeithi, “steel demand will recover firmly both in developed and developing economies, supported by pent-up demand and governments’ recovery programs.”
More recently, analysts at Standard & Poors predicted U.S. steel prices will be “higher for longer” - and not just because of inevitable bottlenecks at the mills amid high demand.
“As steel companies report record profits, they are expected to remain disciplined with regards to U.S. steel production.”
That’s good. It means steelmakers aren’t throwing caution to the wind. They’re not rushing to spend their shareholders’ money in order to upgrade their mills.
It also means they avoid the big mistake of all commodity operators -- spending big bucks planning more production capacity when prices are high -- only to watch prices plummet as all that new capacity comes online a few years down the road.
Lastly, let’s keep in mind another key point. With steel prices marching higher, pressure is growing on the Biden administration to lift Trump-era steel tariffs.
While the American Petroleum Institute and other business groups have lobbied the White House to ease those restrictions, U.S. steel companies (and their unions) have been campaigning to keep them in place. That’s because they fear more dumping of low-cost steel products into the American market by Chinese companies.
I think the tariffs are one part of Trump’s legacy that Biden is likely to quietly leave in place or only partially roll back.
With all that in mind, I think this is a good time to consider stocks within the steelmaking sector.
Right now, Steel is ranked #1 out of the 45 sectors we track.
The sector recently flipped into X-s on its Bullish Percent Index (BPI) chart.
And although, technically, the chart has been on a Sell signal since earlier this month, it is still on Bull Confirmed status -- the strongest designation for this indicator.
Next up is the sector’s Relative Strength (RS) chart. It measures how well the steel sector is performing when measured against the Equal Weighted S&P 500. As you can see, the group has outperformed by a wide margin.
Clearly the sector is hitting on all cylinders. Drilling down deeper among individual steel manufacturing stocks, I have a favorite under-the-radar small-cap steel maker in mind.
Ampco-Pittsburgh (AP) was founded back in 1929.
The company operates in two segments critical to the industrial and high tech economies.
It designs and sells forged and cast engineered steel products. We’re talking specialized alloys that an industrial customer would use in metal stamping and tooling applications, as well as high-strength, lightweight metal allows for aeronautical systems.
It also designs and builds steel components used in the processing of industrial liquids and gases.
As the global economy rebounds, lots of commercial and industrial projects put off by the pandemic are back in the planning and construction stages. This- which should mean plenty of work ahead for Ampco-Pittsburgh.
The stock checks all the right boxes in the Position Key (a premium research tool that comes with Sector Prophets Pro, the premium data platform offered by True Market Insiders).
From left to right, the four blue arrows are telling us…
- The steel manufacturing sector is on bull confirmed status on its BPI chart.
- The sector is strong relative to the market…
- The stock is strong when compared to other companies’ stocks in its sector…
- The stock itself is strong compared to the market as well.
So we’re looking at an attractive industry, an attractive sector, and an attractive stock.
After bottoming out at $1.94 last March, the stock gained as much as 354% (on February 9).
Since then it has pulled back about 23% and is finding support near $6.50. I think Ampco-Pittsburgh has more than enough in the gas tank to go higher still - and within the next handful of days, too.
See, the steel maker is set to report its first quarter results on May 7.
Analysts expect the company to post a profit of $0.08 a share. But given the ongoing rebound in the U.S. economy, I think it can do better and post profits of at least $0.10 a share.
Wall Street has been underestimating the strength of Ampco-Pittsburgh’s earnings ability for a while now.
The company posted Q4 profits of $0.15 a share - triple the nickel a share expected by analysts.
It was the same story for Q3. Analysts expected a profit of $0.06; the company delivered results that were a penny better.
In fact, as you can see in the image above, Ampco-Pittsburgh has topped Wall Street estimates each of its last four quarters.
In reality, the company is not the same one that went into the pandemic. That's thanks to ongoing restructuring and efficiency efforts by CEO Brett McBrayer, who took the job a little less than three years ago.
Since then, the steelmaker lowered its total debt by almost half, while significantly raising it's free cash flow from continuing operations.
My bet is that when May 7 rolls around, the company will once again surpass analysts’ forecasts, putting Ampco-Pittsburgh squarely on the radar of institutional investors.
If it re-tests its previous recent high near $8.80, we’ll have a very quick 29% gain.
Here’s an important caveat. AP is a pretty thinly-traded stock. Even on heavy-volume days it only trades about 250,000 shares. Usually much less than that.
If you’re of a temperament that needs greater liquidity, this might not be the play for you right now.
But considering that this is a firm under new leadership, with a historical propensity to “beat the street “ on earnings…
And considering the strong Steel IRon sector and the economic tailwinds AP currently enjoys…
You might want to consider a stake in AP.
Have a great week,
Guest Editor, True Market Insiders