Optimists jump into cyclical stocks

January 21, 1992|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK -- As many of the nation's largest cyclical companies prepare to release lousy earnings for 1991, investors have suddenly become intrigued by their longer-term prospects, bidding up the price of shares for steel, copper, and chemical companies in a broad display of optimism.

Bethlehem Steel's price rose to $17 a share from $13.25 last week before sliding back a bit yesterday to $16.25, a move broadly echoed in the prices of Phelps Dodge, Inland Steel and USX-US Steel Group, among other companies.

"If you believe an economic recovery is at hand, the place to be invested is not Bristol-Myers and other pharmaceutical companies," which, despite the recession, have registered large gains in profits and share price, said Michael Metz, strategist for Oppenheimer & Co.

"It's Inland Steel and Bethlehem Steel and other cyclical companies like them," he said.

"These companies [have] high fixed costs for debt and equipment, but if you can spread these over a bigger sales base, you have the makings of an earnings explosion."

The steel companies, on average, continue to operate at 75 percent to 80 percent of capacity -- low by average historical standards, but not low for a recession, said Clarence Morrison, a metals analyst at Prudential Securities. Moreover, customer inventories are unusually low because of tighter production systems. This could accelerate demand as soon as a recovery does emerge.

But current conditions have yet to suggest that higher sales may be forthcoming.

Scrap prices, a basic indication for demand, are extremely depressed for most basic industries. Moody's bellwether scrap metal index is down almost 16 percent in the past year.

Aluminum prices, in particular, have been hard hit, with the cost of used beverage cans falling below 40 cents a pound from a more normal level of 55-to-75 cents, Prudential's Mr. Morrison said.

Primary customers for these manufacturers -- most importantly auto manufacturers but also producers of durable goods such as refrigerators, stoves and other appliances -- have been savaged by the recession. Some big markets, such as commercial construction -- a major steel user -- may not rebound for years.

The optimistic scenario ignores the current weakness as well as the structural problems in a few segments of the economy. Enthusiasts argue that many of the most cyclical companies, such as steel producers, have managed to remain at, or close to, break even despite an extremely severe recession (for them) and large restructuring costs.

Steel analysts note that Bethlehem Steel, in particular, has rehabilitated facilities in Maryland at Sparrows Point and in Chicago, resulting in short-term costs and lost volume that will likely not be recurring this year.

But with little evidence of a recovery at hand, demand in the industry is not expected to rise soon.

Many investors, however, seem willing to wait. Mr. Morrison, a longtime analyst, said he has been receiving "extremely unusual" calls from institutional clients, requesting his earning outlook not only for 1992, but also for 1993, 1994 and 1995.

In the past, said Oppenheimer's Mr. Metz, rallies in the stock price of cyclicals occurred over an extended period, as the companies recovered.

"You've had a year's move in a couple days," Mr. Metz said. "The question is, how much is left in the move, even assuming a recovery. My guess is none in the short term."

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