Commodity stocks have witnessed a sharp correction in the recent past. China’s curb on steel production has been one of the catalysts for correction. Additionally, the Evergrande crisis caused some jitters in the commodity market. However, this correction seems like a good buying opportunity.
In terms of returns in the last 10 years, commodities have been an under-performer. This is indicated by the fact that the Bloomberg Commodity Index has delivered negative average annual returns of 2.66%.
It’s also worth pointing out that over a 20-year period, commodities delivered an annual average return of 1.61%. Commodities are therefore an undervalued asset class. A 120-year chart that compares commodity price with the Dow Jones Industrial Average, indicates that commodities have never been so undervalued.
However, a reversal in the long-term trend seems underway. The BBG Commodity Index has returned 42.2% in the last 12 months.
It’s worth noting that real interest rates are likely to remain negative for an extended period. Therefore, even with a likely Fed tapering, easy money will continue to have a positive impact on asset classes like commodities, energy and precious metals.
Another important point to note is that the recent correction in commodities has resulted in an overreaction in several commodity stocks. This presents a good near-term trading opportunity.
Here are four commodity stocks that look poised for a sharp reversal in the near-term. These stocks are also worth considering for the long-term portfolio.
Commodity Stocks to Buy: Vale (VALE)
After touching highs of $23.20, VALE stock has witnessed a swift correction. In the last month, the stock is lower by 26%.
One reason for the sharp correction was a decline in iron ore prices as China moves to curb steel output. The Evergrande crisis also resulted in some jitters for the stock. However, even with these headwinds, the stock looks attractive at a forward price-to-earnings-ratio of less than 5. Additionally, VALE stock offers an annualized dividend of $2.27, which seems sustainable.
It’s worth noting that for Q2 2021, Vale reported an adjusted EBITDA of $11.2 billion. For the same period, the company’s free cash flow was $6.5 billion. Strong cash flows have significantly improved the company’s credit profile.
In terms of growth, Vale expects iron ore capacity at 343 million tons per annum (Mtpa) for 2021 and 400Mtpa for 2022. Furthermore, capacity is expected to increase to 450Mtpa over the next few years. Strong financial flexibility allows the company to invest in growth and sustain dividends.
Of course, demand from China is a key iron ore pricing and cash flow factor. However, investors can still benefit in the short term as a pullback rally seems likely from oversold levels.
Freeport-McMoRan (FCX)
FCX stock is another attractive name among commodity stocks that’s worth buying after the recent correction. From May 2021 highs of $46.1, FCX stock currently trades around $32.80.
Wood Mackenzie recently predicted that the surging demand for renewables will benefit aluminium, copper and zinc. Freeport seems to be best positioned to benefit from secular industry tailwinds.
For the current year, Freeport estimates copper sales of 3.85 billion pounds. Sales are guided at 4.4 billion pounds for 2022 and 2023. With a positive long-term outlook for copper, Freeport is positioned to benefit from higher price and incremental production.
It’s worth noting that for Q2 2021, the company reported operating cash flow of $2.4 billion. Strong cash flows provide headroom for aggressive capital investment and dividends. For the current year, the company plans capital expenditure of $2.1 billion. Investments are guided to increase to $2.5 billion for 2022.
Additionally, Freeport reported net debt of $8.4 billion in Q2 2020. In the last quarter, net debt declined to $3.4 billion. As the credit profile improves, the stock is due for a re-rating.
The company has also indicated that additional cash returns are likely for shareholders after 2021 results. A potential increase in dividends also seems to be on the cards.
Commodity Stocks to Buy: Lithium Americas (LAC)
Lithium, as a commodity, is likely to remain in demand with the electric vehicle industry at an inflection point. Last month, lithium carbonate prices hit an all-time high in China.
Lithium Americas has ambitious growth plans and looks attractive among commodity stocks worth holding for the next few years. LAC stock has moved higher by 40% in the last six-months. The stock still trades 23% below its 2021 highs.
The company has some attractive projects that are likely to deliver long-term value. Caucharí-Olaroz project has an annual production capacity of 40,000 tons per annum of lithium carbonate. The project has a life of 40 years with an annual average EBITDA potential of $308 million.
The Thacker Pass is another attractive project with an annual production capacity of 60,000 tons per annum of lithium carbonate. The project has a mine life of 46 years with an average annual EBITDA potential of $520 million.
From a financial perspective, the company has $500 million in cash. This is likely to fund the development of projects through 2022. Once production commences in the Caucharí-Olaroz (mid-2022), LAC stock is likely to see meaningful upside from current levels.
Rio Tinto (RIO)
RIO stock seems to be another name that’s a victim of market over-reaction. From 52-week highs of $93.30, the stock has declined to around $66. At a forward price-to-earnings-ratio of 4.3, the stock looks poised for a sharp comeback rally.
The recent decline in iron ore price has resulted in a sharp correction for the stock.
However, Jefferies analyst Chris LaFemina believes that Rio will “remain profitable even in a weak pricing environment.” LaFemina further notes that the company’s cost to mine and deliver iron ore to China is approximately $35 a ton. Therefore, even if iron ore price is around $100 per ton, Rio Tinto is positioned to deliver healthy free cash flows.
It’s worth noting that for the first half of 2021, Rio Tinto reported free cash flow of $10.2 billion. Further, the company has a negative reported net debt position of $3.1 billion. With a strong financial profile, dividends are likely to be sustained. Currently, RIO stock offers an annualized dividend of $7.52, which translates into a yield of 11.26%.
Overall, RIO stock looks attractive among commodity stocks for a sharp reversal rally in the coming weeks.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.
