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Commodity Stock Analysis

I thought you’d like to read an article from The Edge. It explains the current conundrum with ag’s, energy, steel, etc. Earnings continue to go up but the stock prices show that earnings should be going down. We are in the middle of great disconnect, and as this article points out, it will certainly be resolved, most likely to the upside in terms of stock prices.

The Edge

Gary Dvorchak, managing partner of Aviance Capital Management, is filling in for Doug Kass today. Doug will return on Thursday.

So What About the Commodities?
9/8/2008 3:08 PM EDT

QuickTake
Bullish COP NUE MOS STR

The damage seems to be done in these stocks, for the most part.

Here is the thing I can’t figure out about some of these commodity names, especially the ags but also steel, oil, etc. I recognize that the stocks are down as the commodity prices fall, indicating that investors expect massive cuts in earnings estimates. How else to explain a ConocoPhillips (COP) trading at 5x 2009 estimates? Or a Nucor (NUE) at 6x? Or a Mosaic (MOS) at 6x? The stocks seem to be forecasting earnings at perhaps half the current estimates for 2009.

I am perplexed, though, why only the buy side seems to be able to read the commodity prices, while the sell-side analysts that cover the companies closely and talk to many levels of management constantly don’t seem to notice. As the stocks get hammered, why are Mosaic’s earnings estimates still going up? Why is Nucor still going up? Even Questar (STR), in that doghouse of an industry known as natty gas, sees its estimates rising.

Click here for larger image.
Source: Aviance Capital Management
Click here for larger image.
Source: Aviance Capital Management
Click here for larger image.
Source: Aviance Capital Management
Click here for larger image.
Source: Aviance Capital Management

Many readers will instantly tell me that it is well known that sell-side analyst estimates tend to get adjusted more slowly than reality, and I completely agree with that. In fact, it is one of the market phenomena my firm utilizes in stock selection. Even if analysts aren’t immediately cutting their estimates 50%, however, why aren’t they cutting numbers even a little? They talk to the companies. Are the managements so clueless they don’t know that their earnings are about to collapse?

I wouldn’t bet that commodity-related stocks are about to experience a new “en fuego” rally, but perhaps a bubbly quarter of spiking spot pricing never flowed through to results. Perhaps more business is done via long-term contracts, and these businesses are more stable than we realize. I do not know, but I do know that there is a mystery here that needs to be resolved. Why are no analysts cutting numbers when it should be so obvious, in theory?

My outlook for these names is simple. Either estimates will roll over — the analysts and managements are clueless and can’t read a Wall Street Journal — and the stocks will go down a little (but not a lot since they are already discounting 50% earnings declines) or earnings will not roll over, and investors will recognize they are far too cheap relative to their earnings power. The damage seems to be done in these stocks, for the most part. Or so I hope.