Markets

These 2 Deep-Value Commodity Stocks Have at Least 50% Upside

As the major indexes post multi-year highs, many investorscredit theinvisible hand of the Federal Reserve.

The Fed 's pump-primingquantitative easing (QE) has acted as a key source ofliquidity for a range ofinvestment classes, from small-capstocks to junkbonds to the leadingblue chips .

The Fed's moves were also expected to boost various commodities -- and the stocks that are pegged to them -- but this entireasset class has started to lag stocks by a wideningmargin in recentquarters . The still-slow globaleconomy is just one offactors affecting them.

But as the global economy stirs to life, demand for commodities could strengthen, boosting pricing. Here are twocommodity producers that have fared badly in recent years, but now hold deep value andupside when the global economy firms up.

Barrick Gold (NYSE: ABX )

This is the world's largest gold producer in terms of production andmarket value , and is a poster child for the keyissue plaguing the gold-mining sector: Rising costs.

In 2009, Barrick mined gold (on acash basis ) for less than $500 an ounce -- this figure is expected to exceed $630 an ounce this year. In light of the drop in gold prices, from about $1,900 an ounce in the summer of 2011 to a recent $1,575, Barrick'sprofit margins have steadily narrowed. That helps explain whyshares hit fresh two-year lows with each passing week.

Yet thanks to a series of new lower-cost mines that are gearing up for production, Barrick's mining costs are finally set to reverse course as we head into mid-decade. Merrill Lynch'sanalysts see Barrick's mining costs falling below $600 an ounce by 2015. Assuming gold prices remain constant, Barrick's margins and operatingcash flow will likely begin to rebound. (Every $50 per ounce in gold prices in either direction is expected to have a $350 million effect on annual cash flow).

Alpha Natural Resources (NYSE: ANR )

For many investors, coal stocks have doled out ample pain in recent years, as surging natural gas prices and stricter environmental regulations have led to a sharp slump in coal demand and pricing. This company's stock has really taken it on the chin, plunging 80% since early 2011.

In light of coal's long-term headwinds, it's hard to see how
this stock will return to the mid-$60s. Still, at about $8, shares
possess deep value, with perhaps 50% upside from here.

In light of coal's long-term headwinds, it's hard to see how this stock will return to the mid-$60s. Still, at about $8, shares possess deep value, with perhaps 50% upside from here.

The keycatalyst won't be a heady rebound in coal prices, but a more constrained cost structure. You can already see the effect of Alpha Natural's cutback of 1,200 employees in its quarterly results. The company posted anet loss of $128 million the fourth quarter of 2012, compared with a $793 million net loss in the fourth quarter of 2011. Though thered ink is likely to continue, Alpha's operating cash flow looks healthier, at about $217 million in the most recent quarter.

Despite coal's dirty reputation in our nation's electric utility industry, it has paths to growth elsewhere. Many steel mills around the world burn a high grade of coal known as metallurgical coal (or "met coal"), and as the global economy rebounds in the next few years, demand for met coal is expected to strengthen. Alpha Natural is the nation's largest producer -- and exporter -- of met coal.

It will take several years for investors togain better visibility into Alpha Natural's capability to generate cash flow, so in the near-term, analysts at UBS say it's wiser to value shares on a price-to-book basis. Although UBS analysts don't see shares rising up tobook value of $22 a share, they say shares could rebound to $13 -- or more than 50% above current levels -- once investors recognize that coal pricing and demand dynamics have at least stabilized and are no longer worsening.

Analysts at Barclays believe that imminent catalysts are indeed in place for a rebound: "The near-term outlook for ANR shares primarily depends on the next move in met coal prices, and we maintain our position that the next move will likely be higher as 2013 progresses." They see shares trading up to $12.

Risks to Consider: A slowdown in the global economy in coming quarters would limit upside for commodity prices -- and these stocks.

Action to Take --> Both of these companies are restraining spending to generate improving cash flow, even if the commodity prices fail to rally. They remain deeply out of favor, though they look poised for a rebound if the global economy builds a head of steam in 2013 and 2014. If you're in search of deep value in the commodity space, then either of these two stocks fit the bill.

-- David Sterman

P.S. -- Interested in learning more about the North American Energy Boom? We've found three companies that could help put an end to the U.S. trade and budget deficits... solve the problem of rampant unemployment... put money back in the pockets of consumers -- and put far more money in your pocket as an early investor. Go here to learn more...

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics

Commodities