S&P recommends marketweighting the S&P 500 Materials sector. Year to date through November 18, this sector, which represented 3.5% of the S&P 500 Index, was down 12.9%, compared to a 3.3% drop for the 500. In 2010, the sector index advanced 19.9%, versus a 12.8% increase for the 500. There are 12 sub-industry indices in this sector, with Diversified Chemicals being the largest at 25.2% of the sector’s market value.
S&P equity analysts have a neutral fundamental outlook for the sector, reflecting the view that cost-cutting actions taken in the downturn and growing demand from emerging markets for metals and mining products are offset by increased macroeconomic uncertainty in developed economies which, we think, is fueling slower commodity price appreciation. Despite very strong first-half EPS growth, the Capital IQ consensus estimate indicates the sector’s EPS gains will moderate as 2011 progresses as commodity price appreciation likely slows and comparisons get more difficult. Its P/E on consensus estimated 2012 EPS of 10.8X is below the 11.3X for the overall market. The sector’s P/E to projected five-year EPS growth rate of 1.1X is above the market’s PEG of 1.0X. This sector’s S&P STARS average of 3.7 (out of 5.0) is slightly below the broader market’s average of 3.8.
The S&P GICS Materials Index is still working on a bullish, inverse head-and-shoulders pattern. To complete this bullish reversal formation, prices will have to jump strongly above the 225 level, which is where a strong area of chart resistance sits from the major price breakdown seen in early August. Prices are back below both the 17-week exponential and 43-week exponential, and the shorter average is still below the longer average. However, the averages have flattened out, a potentially bullish sign, in our view. Relative strength versus the S&P 500 bounced sharply in October and it appears to us that the RS line is bottoming out. We have raised our technical outlook on Materials to neutral with a bullish bias, from bearish.
We recommend marketweighting the Materials sector based on our expectations for more muted commodity price appreciation, which we think is offset by low valuations and an improving technical outlook.
Vale (VALE) is the world’s largest iron ore producer and second-largest nickel producer. The company operates three iron ore mine systems in Brazil: northern, southeastern, and southern. Nickel is produced at Vale’s mines in Canada, Indonesia, and New Caledonia. Vale also mines a variety of other minerals, including copper, coal, and potash. Surging commodity prices meant stronger credit-relevant ratios for Vale in 2010. EBITDA covered interest expense 9.4 times in 2010, up from 5.6 times in 2009. Debt/EBITDA ratio contracted to 1.0 times, from a relatively inflated 2.7 times in 2009. We expect Vale will have little difficulty meeting its financial obligations under all but the most dire of commodity price scenarios. VALE has a 8.27% dividend yield.
BHP Billiton (BHP) is a diversified miner that supplies aluminum, coal, copper, iron ore, mineral sands, oil, gas, nickel, diamonds, uranium, and silver. A 2001 dual-listed merger of BHP Limited (now BHP Billiton Ltd.) and Billiton PLC (now BHP Billiton PLC) created the present-day BHP Billiton. The two operate as separate firms but are overseen by the same board and management team. Shareholders in each company have equivalent economic and voting rights in BHP as a whole. BHP is on strong financial footing. Returns on invested capital have averaged 25% during the past five years and remained greater than 20% even during the global financial crisis. The worth of BHP’s diversified earnings stream was tested and proved. The company has reinvested throughout the cycle. The five-year average EBITDA margin is a very healthy 45%. BHP has a dividend yield of 3.19%.
The table belows displays those material stocks ranked as bullish and very bullish by their equity summary score.