Yahoo Finance Infrastructure Push Could Benefit Investors
Holding true to his campaign promise, President Donald Trump has proposed a plan to rebuild America's worn out infrastructure to the tune of $1.5 trillion over the next 10 years.
In its 2017 Infrastructure Report Card, the American Society of Civil Engineers estimated that the U.S. needs $2 trillion in infrastructure investment to address the system's poor and still-deteriorating conditions. The plan aims to ignite projects across the country by cutting regulatory red tape and speeding up the permitting process.
Should Congress give the green light, the demand for materials and equipment could skyrocket. This ramped-up spending presents opportunity for investors.
[See: 7 ETFs to Invest in Transit and Infrastructure.]
Material stocks across the country, including Steel Dynamics (ticker: STLD) and Freeport-McMoRan ( FCX) are expected to boom from the impending upturn in spending. However, because of the highly cyclical environment that both of the companies operate, investors should be prepared for greater price volatility in owning these stocks compared to the overall market.
Steel Dynamics. At the heart of infrastructure spending is increased consumption of raw commodities such as steel, cement and copper. Steel is particularly well positioned because of the potential for 24 percent import tariffs on steel products.
On Feb. 16, the Department of Commerce recommended duties on imports of steel and aluminum in response to its Section 232 investigation. Import duties can result in higher prices for the end consumer, fewer imports or both. Given the lack of meaningful infrastructure spending since the Great Recession, the spending by the federal government and state government could be significant.
Steel manufacturers can be split into integrated manufacturers such as United States Steel Corp. ( X) or mini-mill operators such as Steel Dynamics. Integrated manufacturers make the most money at the peak of the cycle but can also enter financial distress during the downturn. Mini-mills tend to have less capital at risk, and therefore usually less financial leverage. Steel Dynamics is trading at 7.6 times EV/EBITDA and net debt/EBITDA of 1. EBITDA margins are currently 15 percent and return on invested capital is almost 16 percent with the potential to substantially increase as capacity tightens and/or duties are implemented.
While well positioned, there are risks facing the company including, rising scrap metal prices, pig iron prices and higher energy prices. In most cases, higher input costs can be passed on to the customer in a strong market, but often with a lag. Global capacity growth can also be problem in the long-term, especially in Asia.
Steel Dynamics' stock dividend has grown 10 percent a year in the last five years. The company expects U.S. steel consumption to benefit from improving market conditions including moderated inventory levels. Global market pricing has improved and momentum in North American steel consumption in auto, energy, and construction is expected to continue.
[See: The 10 Best Materials ETFs We Could Dig Up.]
Freeport-McMoRan. Copper is another economically sensitive raw material that benefits from the build out of electric infrastructure. The electric grid in the U.S., while world class by many measures, continues to need investment, especially as the demand for electric vehicles increases and manufacturing continues to shift back to the U.S.
Outside of the U.S., many countries are increasingly using copper for these same purposes in addition to the development of low-cost housing in countries such as India, China, Brazil and South Africa. The International Copper Study Group forecasts demand to grow 2.3 percent in 2018, led by these emerging markets.
Freeport-McMoRan is one of the largest producers of copper in the world because of its 49 percent ownership in the Grasberg mine of Indonesia, as well as gold and molybdenum. The company has survived a tumultuous few years when the company made an ill-timed acquisition of an oil company near the peak of the oil market and it encountered labor disputes in Indonesia. In the last two years, the company has changed its management team, sold the oil assets and has cut its debt load by 50 percent. Grasberg production is also expected to rebound in 2018.
The stock is trading at 4.8 EV/EBITDA and debt stands at 1.6 EV/EBITDA. Morningstar recently raised its price forecast for copper from $2.28 per pound to $2.40 per pound for 2019 based on favorable demand and supply. Freeport's cash costs hover near $1.35 per pound, so the margin profile can be very lucrative as demand continues to improve.
As a sign of confidence in the long-term health of the business, the company recently reinitiated its dividend. The stock offers opportunity for continued earnings growth and multiple expansion. The key risk for the stock would be a material slowdown in China, the largest consumer of industrial metals in the world.
Both the steel and diversified mining industries are highly cyclical and almost entirely commoditized. Rising input costs can only be passed on to consumers if industry-wide prices increase. Both industries require large capital investments, which could pressure cash flows during weak economic times. A company's position on the cost curve for each respective resource is a critical investment consideration, given the volatility of commodity prices.
While there is much to be excited about investing in the above companies in light of the passage of an infrastructure bill and rising global demand, investors should keep in mind that these companies are highly dependent upon economic growth.
[See: 10 Investing Themes to Remember for 2018.]
Disclosure: Leslie Thompson and clients of Spectrum Management Group own Steel Dynamics (STLD) and Freeport McMoRan (FCX).
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