Do Steel and Oil Mix?

09/28/2010 11:28 am EST

Focus: STOCKS

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Updated September 28, 2010

Mark Skousen, editor of Forecasts & Strategies and High-Income Alert, likes the shares of a deepwater oil driller and Brazil’s biggest steel maker, which he says are both dirt cheap.

Offshore drilling contractors like Transocean (NYSE: RIG) and Seadrill (Nasdaq: SDRL) took it on the chin when BP (NYSE: BP) suffered the worst oil spill in history earlier this year [in the Gulf of Mexico].

Now that the oil rig has been plugged, deepwater offshore drilling has made a comeback. Under the leadership of Norwegian billionaire John Frederiksen, the Bermuda-based Seadrill is expanding aggressively to take advantage of the constant search for new oil supplies. It has a fleet of 48 units, none of which are used in the Gulf region.

Frederiksen, one of the world’s wealthiest men, wants to expand rapidly and is acquiring new properties. [Seadrill's subsidiary Seawell Ltd] recently acquired Allis-Chambers Energy. The combined company would have an estimated $1.3 billion in revenues this year.

Seadrill’s earning power has increased so much that in June it paid its first quarterly dividend of 60 cents per share, and then increased its second dividend to 61 cents.

Seadrill is doing well, with profit margins exceeding 35% and return on equity (ROE) reaching 32%. Revenues rose 15% in the past year to $3.5 billion.

At Seadrill’s current stock price (it closed at $28 Monday—Editor), the dividend yield [approaches] 9%.  Seadrill’s management [appears] determined to pay a rising dividend, which is a good sign for prospective investors. 

By most measures, Seadrill is still cheap, selling for [less than five] times current earnings, and [33%] above its book value of $21.

Let’s buy Seadrill (SDRL) at market and set a protective stop of $21 a share here.

Companhia Siderurgica Nacional (NYSE: SID) is Brazil’s largest steel company. It beat expectations in its last quarter, with revenues jumping 55% to $7.5 billion and earnings climbing 167% to $1.9 billion.

With profit margins exceeding 25% and return on equity topping 47%, it’s hard not to like SID’s outlook. The company also has nearly $6 billion in cash, enough to finance its $10-billion debt load easily. [And] Brazil’s economy is expanding at a 9% annual rate.

SID is cheap by almost any measure. [At Monday’s close above $17,] It’s selling for less than five times next year’s [projected] earnings, with a price-to-earnings/growth (PEG) ratio of only 0.7. [A PEG ratio of] less than 1 is considered good.

Executives are so high on the company that they split the stock two-to-one in early April and paid a higher-than-expected $1.16 annual dividend (7% yield).

Let’s buy SID at market and set a protective stop of $13 a share. For those more adventuresome, consider buying the January 2011 $20 calls, which last traded at [around 40] cents.

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