2012 Could Be Gerdau’s Big Year

01/26/2012 3:09 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

You might not know it, given the stock’s poor performance, but sooner or later a couple of big trends will combine to give the Brazilian steelmaker a major tailwind, writes MoneyShow’s Jim Jubak, who also writes for Jubak’s Picks.

The numbers out of Brazil’s steel industry are ugly. How ugly? Uglier than a mole rat. Uglier than the first day of school. Uglier than an Ugli fruit.

Brazil’s steel industry produced a record 35.2 million metric tons in 2011, 6.8% more than in 2010, but “apparent consumption” (the sum of domestic production plus imports minus exports) fell by 4.2%, to just 25 million tons.

And since Brazil’s steel industry has a total capacity of 45 million tons, steel prices haven’t gone up strongly, even if exports did climb 21% in 2011.

In short, there’s nothing in the current picture of the Brazilian steel industry to explain why the American Depositary Receipts of Gerdau (GGB) are up 35.9% from December 19 to 2:13 p.m. New York time on January 26. (Gerdau is a member of my 12-18 month Jubak’s Picks portfolio.)

Part of that jump is due, of course, to the switch from risk-off to risk-on that has swept the entire global market in the last month. Traders and investors have decided, apparently, that the European Central Bank has poured enough money into European banks, that the US economy is growing modestly, and that neither China nor Brazil are headed to a hard landing.

Therefore, it’s OK to move money from safe havens such as US Treasuries to global equities. In the same period that produced Gerdau’s 36% gain, the iShares MSCI Brazil Index ETF (EWZ) climbed 13%.

But that’s only part of the story—since Gerdau has outperformed the ETF so massively.

For that you have to look to the passage of time, which has reduced the months that investors have to count down until growth really kicks in for Gerdau, on expectations of a recovery in the growth rate in the Brazilian economy—after a year of nothing but bad news on growth—and on steel-specific expectations connected to the coming double whammy of Brazil hosting the Soccer World Cup in 2014 and the Summer Olympics in 2016.

The expectation, and I think it’s accurate given the state of the required infrastructure in Brazil, is that the two events will be produce a huge boom for any company connected to construction projects. And as a company focused on long-steel products, such as rebar, boy oh boy is Gerdau connected to construction. (It also doesn’t hurt that Gerdau is one of the world’s lowest-cost steel makers.)

You can see that anticipation built into the earnings estimates for Gerdau. Credit Suisse sees the company earning .88 reais a share in 2011, and then 1.71 in 2012 and 2.22 in 2013. That would drop the price-to-earnings ratio for the underlying Brazilian shares from 17.3 in 2011 to 8.9 in 2012, then 6.8 in 2013.

In June 2011, I set a target price of $16 a share for Gerdau’s ADRs by the end of the year. With Brazil’s economy slowing and investors running from risk, that sure didn’t happen. The ADRs finished 2011 at $7.81.

But 2012 is not just another year—it’s also a very different year. (I believe.) My end of 2012 target for Gerdau’s ADRs is $16.80—although, please note, I don’t expect that ADRs to arrive at that level in one clear run. Expect instead a rollercoaster ride to the target.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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