Sector Screener: plenty of good reasons to buy these unloved stocks

It’s fallen out of favour with investors, but columnist Robert Stephens believes now is the time to take a contrarian stance and back this unpopular sector.

The industrial metals and mining sector is decidedly unpopular among investors. In fact, it is one of the FTSE 350’s worst-performing sectors since the start of the year, having declined by 15% year-to-date.

Since the fundamental aim of all stock market investors is to buy shares at low prices and sell them at far higher prices, the sector’s decline presents a potentially stunning investment opportunity.

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Indeed, buying shares in a company that is relatively unpopular among other investors, and in doing so taking a contrarian stance, can prove to be extremely profitable in the long run. It allows an investor to purchase high-quality companies at heavily discounted prices that provide scope for significant share price growth.

An improving global economic outlook

The sector’s popularity among investors has diminished as they have become increasingly concerned about the world economy’s outlook, with the current period of rising interest rates and above-target inflation deemed unlikely to prompt high levels of economic growth. According to the Organisation for Economic Cooperation and Development (OECD), the world economy’s growth rate will fall to 2.7% this year from 3.2% last year, as the impact of interest rate rises on activity levels is fully felt once time lags have passed. And, with the Federal Reserve seemingly set to maintain a hawkish stance, further interest rate rises would be unsurprising.

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However, the current era of rising interest rates and high inflation will ultimately abate. In fact, it will be extremely challenging, if not impossible, for the Federal Reserve to perfectly judge the extent to which interest rates should rise. They could easily overreach on their programme of monetary policy tightening to leave inflation languishing below their 2% target, given that it is currently just 100 basis points higher at 3%.

This matters to the industrial metals and mining sector because an end to monetary policy tightening, and even a decline in interest rates, would provide a fillip for the world economy’s growth rate. And, with the International Monetary Fund (IMF) expecting interest rates to eventually settle at a similar level to those experienced pre-Covid, the long-term prospects for the world economy, and demand for a variety of metals and minerals, are likely to drastically improve versus today’s downbeat outlook.

China’s long-term recovery

Another factor holding back the industrial metals and mining sector over recent months, and which could also ultimately become a positive catalyst, is China’s economic performance. China is the largest importer of a range of commodities, so its economic performance greatly matters to the sector. For example, it accounts for 55% of the world’s copper consumption and over 70% of the world’s iron ore imports.

Since ending its zero-Covid policy towards the end of last year, China’s recovery has misfired. Economic data has been mixed, with inflation declining to zero and manufacturing PMI readings struggling to reach expansionary territory. While further volatility cannot be ruled out in the short run, China’s economy is ultimately expected to return to rapid growth.

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In fact, the OECD forecasts that the world’s second-largest economy will deliver GDP growth of 5.4% this year and 5.1% next year. And, with economic stimulus increasingly likely to be enacted should deflation remain a threat and manufacturing data continue to disappoint, the demand outlook for commodities such as copper and iron ore is likely to significantly improve. This could drive their prices higher, thereby leading to greater profits for their producers.

Net-zero opportunities

The industrial metals and mining sector is also worth buying into today because of its key role in the world’s shift from fossil fuels to cleaner forms of energy. This is set to mean heightened demand that may not necessarily be met with a commensurate increase in supply, thereby raising the prices of a range of metals and minerals.

Copper, for example, is used extensively in electric vehicles and renewable energy infrastructure. With supply growth being limited due to a lack of new discoveries over recent years, demand is likely to far exceed supply over the coming years. Steel-making ingredient iron ore, meanwhile, is also used in renewable energy infrastructure and is therefore likely to experience growing demand as the world persists with its transition to net zero.

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Certainly, the prices of both commodities are unlikely to move higher in a uniform fashion. But with net-zero commitments having been made by major economies, rising prices that lead to growing profits for copper and iron ore producers are likely to be experienced over the long run.

Antofagasta

Copper miner Antofagasta (LSE:ANTO) is well placed to capitalise on growing demand as China’s economy returns to form, the world economy’s growth rate improves and the push for net zero continues.

Certainly, the Chile-based company has experienced notable challenges over recent months. Production has been disrupted by a drought and delays in bringing its desalination plant online, which led to a decline in guidance provided for the full year in its recently released second-quarter production update. However, it is set to become overwhelmingly dependent on seawater and recirculated water over the long run. This should provide greater consistency in its operational performance, with weather-related challenges becoming less impactful.

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The company’s shares have become increasingly unpopular over the past six months and have fallen by 14% during the period. Although it continues to trade on a relatively high forward price/earnings (PE) ratio of 26, its financial performance is set to improve as demand for copper rises amid a more buoyant global economic environment. In tandem, its net cash costs declined by 3.9% in the first half of the current financial year as an era of rampant inflation finally draws to a close.

With modest debt levels that amount to just 28% of net assets, the firm is well placed to ride out short-term economic difficulties to capitalise on an improving operating environment. While political risk in Chile is heightened, and could mean further increases in the taxes paid by mining companies, Antofagasta’s risk/reward opportunity remains highly favourable.

Rio Tinto

Rio Tinto (LSE:RIO) is also well placed to capitalise on China’s economic recovery, the world’s push for net zero and an improving global macro outlook. The Australia-based firm derives 56% of its revenue from iron ore, while also producing aluminium, copper and minerals across a wide range of countries.

Its shares have declined by 18% over the past six months and now trade on a forward price-/earnings ratio of just 9.8. This suggests they offer excellent value for money and include a wide margin of safety. When combined with a dividend yield of 7.5% from a payout that was covered 1.7 times by earnings per share last year, the company’s total return could prove to be relatively high over the long run.

Rio Tinto’s latest quarterly production update was mixed. Although it expects to deliver iron ore shipments in the upper half of its guidance range for the full year, downgrades elsewhere highlight ongoing industry-related challenges. While they may persist over the near term, the company’s debt-to-equity ratio of 23% shows that it has the financial means to overcome temporary global challenges.

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Indeed, both Antofagasta and Rio Tinto are set to successfully ride out present economic difficulties to capitalise on long-term growth opportunities. Their exposure to commodities that are central to the world’s push for net zero means they are likely to experience growing profits as increases in demand outpace supply growth.

And with the world’s economic prospects, along with those of key importer China, widely expected to improve, now seems an opportune moment to adopt a contrarian position towards both stocks while they remain unpopular among most investors.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.