Playing Long-Term Global Growth in the Steel Sector (CPSL, NUE, X, AKS)

While some pundits debate the possibility of a worldwide, double dip recession, it is hard to disregard facts; so lets look at some facts that relate to worldwide growth in the steel sector. 1. China continues to grow at a 10% yearly rate. 2. India continues to grow at 6% per year. 3. Steel demand from those two countries, according to Credit Suisse, is now running at pre-2008 crash levels 4. The president of the China Iron and Steel Association (CISA), Deng Qilin, stated on February 5 that apparent consumption of crude steel in China is expected to grow by 8-10 percent in 2010. 5. Worldwide steel production is ebbing and will be headed lower 6. Major producers are beginning to liquidate inventory (which is typically a contrarian’s indicator) All these metrics point to the same thesis: steel producers with profitable business metrics will outperform the market in the long-term if bought on short-term weakness. The key is finding steel producers with the highest return on capital, the highest gross margin, and very low debt levels. If you look at many of the major steel producers, such as U.S. Steel X, Nucor Corp. NUE, and AK Steel AKS, you will see that none of them has positive returns on assets or capital, most do not have a positive return on equity either. Furthermore, many of these companies have low gross margins (AK Steel excluded) and negative earnings. Add on the fact that these companies’ debt levels are among the highest in the industry and you have strike three. So the search is on for a company that is the polar opposite of the above companies—China Precision Steel CPSL. China Precision Steel, which produces and sells precision ultra-thin and high strength cold-rolled steel products, has some of the highest return on assets/equity/capital (4%, 5.4%, and 5.4%, respectively) of any steel company, a profit margin and gross margin higher than 90% of the industry (6.55% and 10.10%, respectively), and has a super low debt/equity ratio of 0.21x. This is also the only company I can find with all three of those key metrics. CPSL’s revenue and earnings growth is also greater than 90% of the industry; they are scheduled to grow 16% per year for the next five years. The stock is scheduled to make $0.19 next year, giving the company an 8.52 P/E, which is lower than all the above companies. Coupled with that sizable growth rate, that gives CPSL a PEG ratio of just 0.53, which means it is HUGELY undervalued. On a technical basis, the stock has sold off heavily over the past year, off from a high near $3.30, fully reflecting the market’s concerns about worldwide growth. Though the stock is not as low as its 2008 level ($0.86), this still represents a value, as investors are now able to see that the world is not falling apart completely. The company’s cash flow is hovering around the flat line (though skewing positive in recent quarters), though much of this year’s negative flows have been the company ridding themselves of long-term debt and picking up fixed-assets, which will bode well for them as demand continues to increase. I rate the stock as a Strong Buy, and will be picking up shares of CPSL around $1.50-1.60. This is a five-year play with a price target north $3.00 (100% return, 20% return annum).