Friday, August 28, 2009

Capital & Crisis Hotline -- New Buy Recommendation: Titanium!

Agora Financial
Agora Financial's Capital & Crisis

Capital & Crisis Hotline -- New Buy Recommendation: Titanium!
August 28, 2009

"My own suspicion is that many failures are merely a matter of timing. What used to fail now works. What once was a sure thing now no longer works."
-- Felix Dennis, How to Get Rich

Dear Capital & Crisis Reader,

Yesterday, Boeing's 787 announcement sent shares of a certain group of stocks up strongly, even as the rest of the market declined. (This was in the morning, before the market turned up later in the day.) Boeing's own stock was also up 8% on the news.

Boeing said it would fly its 787 Dreamliner for the first time in 2009 and would start taking delivery of the new planes by the fourth quarter of 2010. That was sooner than Wall Street expected. Before no one thought the planes would arrive before 2011.

The 787 is a much-watched next-generation aircraft. There are nearly 900 new planes on order. And to date, there have been a number of delays and production problems. But this announcement firmed things up in aerospace land. The clouds seemed to part.

As MarketWatch reported: "[The announcement] removed a lot of uncertainty in the aerospace sector and helped lift the Dow Jones U.S. aerospace index by nearly 3%." The new jets have many subcontractors who will all feed on the new business and benefit from the quickened timetable.

The Silk Roads in the Sky
"When I dipt into the future far as human eye could see;
Saw the Vision of the world and all the wonder that would be…
Saw the heavens fill with commerce, argosies of magic sails."
  -- Alfred, Lord Tennyson, "Locksley Hall"
I've been watching developments here, and in fact, my next buy recommendation for you is based on some of the historic changes happening in air transportation. One of the key drivers of this change is what I call the Silk Roads of the sky. I'll share with you the details of aerospace's $6 trillion backlog for new aircraft -- which will double the global fleet over the next 20 years.

In large measure, new and booming trade routes linking all kinds of cities and markets flung all over God's green footstool. There are hundreds of new airports planned and thousands of new planes that will connect China to Africa to the Middle East and more. I'll also share with you details on a metal that is key to the next-generation aircraft, all of which aim to be lighter and more fuel-efficient than existing planes.

I've been working on your next issue all week. But now I have a bit of a problem. I'm a little worried that yesterday's news could generate a lot of buzz as the market digests the implications of Boeing's news. Already, the stock I want to recommend was up nearly 7% yesterday. (And is up again in early trading…)

I am like a whale hunter eager to throw his harpoon before the other fellow spears him first. So I am going to give the buy recommendation today and only the brief version of the story. I'll get you the full story no later than next Friday. That way, you can buy a little now, just in case it runs away from us. (And if not, so much the better…)

Titanium Is Key to the New Aircraft

The thing about the new aircraft is that they are titanium intensive. Titanium is a silvery, lustrous metal that is corrosion resistant and has the highest strength-to-weight ratio of any metal. Aircraft manufacturers love titanium.

The market has crushed the price of titanium in this financial crisis, along with everything else. Demand fell dramatically in the short term, though the longer-term picture looks pretty good thanks to all those new aircraft. That creates some space for us to buy a quality operator now.

Titanium Metals (TIE:nyse) is one of the largest titanium companies, with sales of over $1 billion. The company's melting and mill operations make up about 20% and 18%, respectively, of global capacity. It is the only titanium producer with major plants in the U.S. and Europe, the main markets for titanium products. It is also a major producer of titanium sponge, a raw material used for making titanium products, and a large recycler of the metal. Titanium doesn't mine titanium, but buys the ore from mines in Australia and South Africa.

The biggest driver for titanium prices is aerospace, though it has many other growing applications. So TIE's fortunes will ebb and flow with the aerospace order book.

Now is the time to buy, though, as titanium prices are way down. Sentiment is terrible on the stock, with most analysts only lukewarm to the idea. Most of the near-term news is bad. That gives us a great price to get in on a promising long-term story. Of course, this is already in the process of changing, thanks to yesterday's announcement.

Even in this depressed environment, TIE will still generate about $80 million in free cash flow this year. So we are not buying a lit match here. TIE has the stamina to get through this trough. We'll buy now and wait for the rebound.

Let's put it through the paces of our investor's CODE.

C heap? With titanium prices where they are, TIE is not going to earn much -- maybe 20 cents per share this year. On that basis, it doesn't look so cheap. But remember, those numbers are depressed. In good times, this stock can earn over a buck. (It earned $1.29, $1.38 and 89 cents in 2006, 2007 and 2008, respectively.) TIE is a cheap call option on rising titanium prices. In the meantime, it has the balance sheet and cash flow to buy back stock and lay the groundwork for the upturn.

The other number I like to focus on is replacement value. Basically, I ask what it would take to rebuild or make anew the existing assets. This is hard to figure with titanium. Good data on greenfield expansions and add-ons to existing mills and plants are harder to find. But my educated guess, based on expansions by competitors and TIE's own expansion in recent years, is that TIE's replacement value is around $10 per share. For instance, titanium sponge plants alone could run you over $30,000 per tonne and take three years to build. TIE has 12,600 tonnes of sponge capacity. TIE also has nearly 90,000 tonnes of titanium melt and mill capacity to make ingots and other products.

Book value, too, is around $6 and change. This understates replacement value, since it is based on historical costs. But since the stock is not much above book, I think we're OK on the downside.

There are two other U.S.-listed competitors, RTI and Allegheny Technologies. The stock prices mostly run together, though TIE is the best performer over the last five years and has the most exposure to aerospace. TIE is also the only one that is debt free.

O wner-operators? We have Harold Simmons, who owns 52% of the stock either personally or through entities he controls. I'll have a lot more on Simmons in the next issue, as he is an interesting character in his own right. Some might not like being a junior partner to a controlling shareholder. However, academic research and my own experience show that riding the coattails of a successful investor is a pretty good way to make money in stocks. And Simmons has had a great deal of success, as I'll get to in your next letter.

D isclosures? Some might bellyache about the lack of quarterly conference calls and the fact that Simmons doesn't do the dog and pony show stuff that Wall Street loves. I'm OK with this. We own Leucadia National (LUK:nyse) and Seaboard (SEB:amex), both instances of companies with large controlling shareholders who operate in this way. The public disclosures are good enough.

E xcellent financial condition? TIE is in great financial shape, thereby allowing us to avoid the usual snake in the grass during bad times -- too much debt. It finished the last quarter with no debt and a $106 million in cash. TIE should continue to build cash here as it cuts capital spending.

There is a lot are more that I'll share with you in the issue. In meantime, I recommend you pick up shares of this well-financed company in a business with good upside potential over the next several years. (It was a $40 stock a few years ago.)

I don't think we'll have to wait all that long for a recovery. In addition to the announcement by Boeing, we had an encouraging durable goods report released on Tuesday. Orders for big-ticket items -- aircraft being the biggest of the big-ticket items so tracked -- rose 2.5% in July. That's the fastest pace in two years. By mid-2010, TIE's business will be much better, and the stock will move well before then.

Recommendation: Buy Titanium Metals (TIE:nyse) up to $12 per share.

*** Join Me in Australia & New Zealand
"It used to be that our standard of living was so much better in the West that we were the only ones who could afford these natural resources, but that's no longer the case. We're facing competition from around the world, and that's why the natural resource prices have been headed higher."
-- Rick Rule, president, Global Resource Investments
In January 2010, I plan to take a small group of readers with me to Australia and New Zealand. We're going to have a great time exploring these two countries -- enjoying the scenery and culture and eating well, I assure you.

We'll also have Rick Rule along for part of the trip. You may know Rule, as he is one of the most successful resource investors alive. We'll get to pick his brain and meet some of his contacts in that part of the world. We're also going to get to spend some time at his farm outside of Auckland, New Zealand.

My friend Dan Denning, who used to edit Strategic Investment will also be there. He's been living in Australia for the last few years, covering the resource scene there. We'll get some insights from him as well.

It's not all about investing. As I say, we'll have plenty of time to explore. The Featherdale Wildlife Park in Sydney… the old wharfs and wool stores outside of Melbourne at Corio Bay… the windswept drama of Shipwreck Coast with its imposing limestone cliffs…

In New Zealand, we'll see Palliser Bay by helicopter and stay at the extraordinary Wharekauhau Country Estate, a 5000-acre working sheep station of forests, lakes, mountains, bush and open country with 16 miles of dramatic coastline. In Queenstown, we'll take a private winery tour and see the surreal landscape where The Lord of the Rings was filmed.

It's going to be a great trip. In fact, it's a once-in-a-lifetime kind of trip, and my wife, Carol, is coming along too.

The trip will be from Jan. 14-29. If you are interested in coming, contact Barbara below and lock down a spot. There are only about 30 slots maximum, so don't wait too long!

Barbara Perriello
Director, Opportunity Travel
Phone: (800) 926-6575 or (561) 243-6276

*** Peak Stimulus

Last week, I talked about all of the stimulus spending aimed toward infrastructure. I wish I had this chart then, but better late than never.

Take a look at this next chart, which shows you how the stimulus spending reaches a peak sometime in early 2010 at $57 billion and then takes a dive.

You have probably heard the idea of Peak Oil. This is the idea that global oil production will peak at some point and then decline, following the natural pattern of an individual oil field. This chart shows you "Peak Stimulus."

Of course, the government can always decide to spend more. But as it is now, this is a pattern of spending we can expect to distort the various sectors it flows to. You can see also on the chart where the money goes, including that big red layer that goes toward highways and transportation.

We may yet see a surge in business activity as we get to 2010. But after that, we'll see if this seeming recovery in the making is real or manufactured by funny money.

*** Reader Mail

A reader writes in:
"Dear Chris,

"I'm leery about investing in methanol because of the rising price of coal. Ethanol became a disaster because of the high price of corn. I am invested in coal and avoiding methanol. Would appreciate your comments."
Our play on methanol is Methanex (MEOH:nasdaq), which makes methanol from natural gas. So the rising price of coal does not have much impact on it. The Chinese, however, make methanol from coal, which they then blend with gasoline. A rising price of coal could actually benefit Methanex, since its competitive position via its cheap natural gas feedstock would only get wider.

I'll have more on methanol and Methanex in your next letter, as a result of my visit with the Methanol Institute. Hang tight.

Another reader writes in, with a common worry:
"Dear Chris,

"I have been reading about Einhorn's rather large position he has taken on SPY puts [which would gain in value if the market fell]. My question is simple. If Einhorn is correct… then everything is going to get hammered, including the resource and energy stocks in the portfolio. I was thinking about getting out and into cash until a direction can be seen (and profitably played, perhaps).

"Although I agree with your thesis on [individual companies], in a large downturn, they will be hurt. The same applies to GPOR and MCF, both of which I like. But the downside in a general market sell-off can be huge, and these good companies will be hurt.

"I would simply like your take on our overall portfolio risk here, if you don't mind."
This is, as I say, a common concern. It seems many readers are worried about the overall market. I'm a little worried too, I have to say. Even though I try hard not to be a market timer, which I think is a losing strategy, a 50% move in less than a year makes me think that we're due for some cooling off.

And I do agree that a stiff market correction will take nearly all stocks down, as happened in 2008. However, I deal with this worry in a different way than you suggest. In my experience, such market calls are very hard to get right. I would advise you to not make such market calls at all. If you focus your energies on trying to guess what the market is going to do next, it will handle you like a rodeo clown handles a bull.

(Einhorn, a great investor in many ways, may be exceeding the limits of his genius in his market call, like a skilled handicapper trying to pick the horses that will finish first, second, third and fourth in every race. His great skill is in figuring out individual companies, but as for calling the market overall, he is a babe in the woods -- like the rest of us.)

Instead, I would look to control how much exposure you have to stocks. Lighten up your exposure to stocks if it makes you sleep better at night. Maybe take half-positions in the names you like. How much risk one takes is a personal matter, and I can't really help you there.

Suffice to say that any stock I have a buy on is one I think will ultimately trade higher than the price that prevails today -- even though we may have to pass through some valleys to get there.

Enjoy your weekend, and look for your full issue next week.


Chris Mayer

P.S. Don't forget to check out that Australia/New Zealand trip. Shoot an e-mail over to Barbara Perriello for details, at , or call (800) 926-6575 or (561) 243-6276.

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