Week 272 - Ten Commodity Producers with Improving Fundamentals

Situation: There are only a few ways that a retail investor can buffer her stock portfolio against losses during a Bear Market. To build that buffer, we suggest including stocks from 4 different types of companies:

1) those that are “shareholder-friendly” in that the company pays a good and growing dividend, e.g. Johnson & Johnson (JNJ); 

2) those that have Tangible Book Value and maintain a clean Balance Sheet in that long-term debt is less than 30% of total assets and the company is able to fund its dividends from Free Cash Flow, e.g. Wal-Mart Stores (WMT);

3) those that sell products having strong Brand Recognition worldwide, based on value-pricing and utility, e.g. Microsoft (MSFT); 

4) those that produce commodities and have a stock price history that roughly tracks the commodity “supercycle” rather than the S&P 500 Index. This week we look more closely at that group of companies, to uncover stocks likely to track the next commodity supercycle.

This is a timely endeavor because there is reasonable evidence that the next supercycle is just now starting. In other words, the Dow Jones Commodity Index has recently “tested” the low set in late 1998, and is now rising. Yes, the last commodity supercycle began following a recession in Asia and was launched by a massive build-out of infrastructure in China that didn't stabilize until 2014. The trigger for the next supercycle will only become clear in retrospect, but Creative Destruction can be counted on to co-produce the event. Brexit may be the herald for what’s coming. 

Mission: Using the 2016 Barron’s 500 List, we’ll select commodity producers that have shown improvement based on these metrics that Barron’s editor uses to rank companies with sufficient revenues to be included on the Barron’s 500 list: 1) median 3-yr cash-flow based ROIC; 2) 2015 ROIC vs. 3-yr median; 3) 2015 sales growth. Then we’ll analyze those companies by using our standard spread-sheet (see Table).

Bottom Line: Some commodities track (or even predict) market cycles. For example, the American Chemistry Council’s “Chemical Activity Barometer” tracks the economy and is helpful in predicting recessions. But we’re looking for a way to track (or even predict) the rise and fall of a Commodity Supercycle that spans 2 or 3 market cycles. Those cycles are long because large amounts of capital have to be deployed upfront to get things out of the ground in scalable quantities, whether those things are in liquid, solid, or plant form. We’re looking for a company whose stock was moderately impacted by recessions in 2001 and 2008 but mainly tracked the infrastructure buildout in China. Mosaic (MOS), a fertilizer producer, is one example; another is Caterpillar (CAT), which makes heavy equipment used in construction, mining, drilling and farming.

Risk Rating: 8 (where Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into XOM, and own shares of CAT and ADM.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is current 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%.

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