Amidst intermediate corrections or rallies, asset classes tend to have an extended period of bull or bear market. A secular bull market for an asset class is a perfect time to remain invested. On the other hand, price and time correction can extend beyond a decade in bear markets. This column discusses stocks for exposure to an undervalued asset class likely to witness a comeback rally.
Without extending the suspense, industrial commodities are the most undervalued asset class. To put things into perspective, the Bloomberg Commodities Index has delivered negative returns at a CAGR of 0.6% in the last 20 years. During this period, the returns for all major asset classes have been positive, with U.S. equities and gold being the leaders.
Sluggish commodity prices have resulted in an underinvestment in the mining sector. In the coming years, the supply deficit will likely translate into a meaningful rally for industrial commodities. It’s worth noting that copper is already surging higher. There are expectations that the metal will touch record highs in 2025.
Let’s, therefore, talk about the undervalued industrial commodity stocks to buy for robust returns.
Freeport-McMoRan (FCX)
Freeport-McMoRan (NYSE:FCX) is possibly the best stock to consider for exposure to copper. In the last 12 months, FCX stock has trended higher by 14.3%. The rally will likely sustain, with a bullish outlook for the metal for the coming years.
There are two reasons for copper trending higher. First, low investment in the mining sector has translated into a supply deficit. Further, copper is among the metals likely to see strong demand on the back of global decarbonization efforts. According to UBS (NYSE:UBS), the recent rally in copper prices is “just the beginning.”
Specific to Freeport, operating cash flow for 2023 was healthy at $5.3 billion. With the upside in copper, OCF and free cash flows could be higher this year. That provides ample flexibility for capital investments and dividends. For the year, copper sales should remain at the same level as in 2023. However, gradual production growth is expected in 2025 and 2026. Assuming a sustained uptrend in copper, the growth outlook is positive.
Vale (VALE)
In my view, Vale (NYSE:VALE) is the most undervalued commodity stock. In the last five years, VALE has remained sideways and currently trades at a forward price-earnings ratio of 4.6. Further, the stock also offers a healthy dividend yield of 9.75%.
It’s worth noting that business developments for Vale have been positive. In December 2023, the company reported its highest monthly iron-ore output since 2018. The iron ore business remains the cash flow driver.
However, Vale is investing in metals that will support global energy transition. That primarily includes copper and nickel. For Q4 2023, the company reported a 50% increase in copper production, the highest since 2018. Nickel production was also in line with the guidance.
For Q4 2023, Vale reported free cash flow of $2.5 billion. That implies an annual FCF potential of $10 billion. Therefore, there is ample flexibility to make aggressive capital investments and sustain dividends.
Rio Tinto (RIO)
Rio Tinto (NYSE:RIO) is another commodity stock that has remained sideways for an extended period. The stock trades at an attractive forward price-earnings ratio of 8.2 and offers a dividend yield of 8%. I expect a big breakout on the upside if commodity prices trend higher on the back of potential rate cuts.
The first reason to like Rio Tinto is its strong fundamentals. For 2023, the company reported EBITDA and operating cash flow of $23.9 billion and $15.2 billion, respectively. Further, the net debt position was low at $4.2 billion. With high financial flexibility, Rio is positioned to make significant capital investments and sustain dividends.
The second reason to like the company is its focus on decarbonization. For Rio Tinto, the iron ore business remains the key cash flow driver. However, the company is investing increasingly in energy transition metals, including copper, lithium, aluminium and titanium dioxide. In the next five years, the company’s portfolio will be diversified, prioritizing decarbonization. With these positives and considering the valuation, RIO stock is a steal at current levels.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
