“An Incredible Opportunity …. My newest pick is a scrap metal recycler on the verge of breaking out”

By Travis Johnson, Stock Gumshoe, August 18, 2010

Well, the questions have been pouring in for months about this newsletter … so finally I’m taking a look. This teaser comes in from Hilary Kramer, urging you to be a charter subscriber to her Breakout Stocks Under $5 newsletter, which looks for, you guessed it, stocks trading under $5 — a category that some publishers reflexively refer to as “penny stocks” and that is typically ignored by most institutional investors due to the (perceived, at least) extra volatility in such low-priced shares.

You may well have heard of Kramer, she’s been a talking head on various finance shows for a long time, and an AOL Finance pundit, though I guess she probably got most of her TV exposure on the PBS Nightly Business Report where she has been a stock-picking regular for years (not sure if she still is). Now, though, she’s seen the light and jumped on the newsletter bandwagon — with the same publisher (Investorplace, also home to Navellier and Robert Hsu) also bringing out a new letter from Maria Bartiromo, they seem to be clearly trying to capitalize on “brand name” talking heads.

Surprisingly enough, her relatively well-known name and her focus on relatively small cap stocks (which means they’re probably capping the subscriber list), means that the newsletter is surprisingly expensive at $995. It’s way too early to know whether or not it will be worth that kind of money, of course, but it seems like a lot for a new letter in a sector that’s already pretty widely covered by lots of established newsletters. Nancy Zambell, a colleague of Kramer’s at the same publisher, similarly has a new low-priced stock letter … but it’s a bit broader with an “under $10” mandate and it costs a tenth as much to subscribe. To be fair, Kramer also has a less expensive letter still adding “charter” subscribers, she’s now helming the GameChangers newsletter that was started by the late Georges Yared.

But that’s just a gut reaction — who knows, maybe she’ll make millions for her subscribers … all I can do is try to identify the latest stock she’s teasing, so let’s get right to it.

As of the weekend, she was calling this a “$3.32 stock headed for $7” … so there’s one clue. Here’s some more of her pitch:

“There is so much to like about this stock I almost don’t know where to start.

“I’m going to give you some details right now, but the bottom line is that I want you to buy this stock today. It’s an easy double, and the sky is the limit from there.

“This company has carved out a critical niche in a huge and still expanding industry — recycling. Most people don’t realize that recycling accounted for an amazing 2% of the nation’s GDP last year.

“My newest pick is a scrap metal recycler on the verge of breaking out”

There’s quite a bit in the tease about surging steel demand in general, but that doesn’t help us much in identifying the stock … here’s some more that might be useful”

“Growth in the domestic steel industry — this company’s #1 customer — has tripled….

“… A diversified product mix sets it apart from competitors. This company processes and sells everything from aluminum to zinc and everything in between. This is a huge plus for us because it protects the company from price volatility in any one metal.”

And …

“Top notch management — this team has expertly guided the company through tremendous growth, smart but aggressive acquisitions (they’ve acquired more than two dozen companies).

“It’s the perfect takeover candidate. The company will likely put itself up for sale and be snatched up by a mega-cap steel producer at a significant premium, handing us a monster payout.”

And then one last clue … and inducement ….

“The stock took a 35% haircut this spring on falling scrap metal prices so it’s a steal (forgive the pun) at today’s price. But you must act quickly! The stock has already started to move and if you miss this opportunity to buy at this deeply discounted price, I guarantee you will regret it.”

So what company is she teasing? The Thinkolator sez it must be … Metalico (MEA)

This is indeed a very small cap steel recycling company — market cap is down near $160 million, and they have another $100 million or so in debt (almost all steel companies carry pretty big debt loads, it’s a very capital-intensive business). They have bounced back with some big revenue and earnings growth in recent quarters, though that’s typical of the other steel recyclers as well (bigger competitors include Schnitzer Steel (SCHN) and Steel Dynamics (STLD)), and this industry is nothing if not highly cyclical — all of those stocks got clobbered in the downturn, and came roaring back when investors concluded that the world wasn’t ending.

And yes, Metalico has taken a significant hit over the last few months — and it did close at $3.32 on August 12, though it’s up slightly from there at about $3.55 right now. I suppose you can say that the shares took a 35% haircut this spring, but overall the stock is down about 50% from its recent high of near $7 and has done significant worse that those two nearest competitors over the last tumultuous six months or so. They also missed earnings estimates just a couple weeks ago, but there are only a few analysts looking at the shares and they’ve had a terrible time getting estimates right — over the last year they’ve been alternating whether the earnings estimate was way too high or way too low, but there’s probably no particular reason to believe that their forward estimates will be accurate. If you do choose to give those forward estimates some weight, they’ll tell you that the company should earn 39 cents per share this year and 48 cents next year, which gives them a very low forward PE ratio of about 7 (the trailing PE, the one using actual results, is more sobering at 23 — but of course, that includes some quarters of extremely low steel demand).

So a couple analysts think the company should grow earnings rapidly, and the shares are pretty inexpensive looking on their face — but it’s worth noting that pretty much all steel companies are fairly inexpensive based on forward earnings, even the big guys like Posco (PKX) and Arcelor Mittal (MT) trade at single digit forward PE ratios, and MEA’s competitors in the scrap steel recycling business likewise are pretty inexpensive — STLD has a similar forward PE of about 8, and SCHN is a bit pricier at 11. They all have slightly different product mixes, of course, and different growth profiles, but they also all fundamentally depend on global steel demand and compete for the same raw scrap materials or iron ore… which means that as industry and infrastructure growth go, so go the steel companies. Metalico might arguably be expected to close the valuation gap with some of its competitors, or to grow faster than the industry if they continue to roll up smaller scrap businesses … but you could as easily argue that when the future is uncertain and valuations universally pretty low in a sector, the wiser path might be to go with the big and established players.

Kramer has been a big fan of Metalico for years, recommending it several times in whatever venue she had available (PBS, AOL, etc), and at sometimes much higher prices — I don’t know if it’s just an overwhelming conviction in this company or stubbornness, or whatever else, but she recommended the shares publicly in 2007 , then was pounding the table for the shares as they had fallen to $13 and then $11 or so two years ago (they had already fallen from $18, and were in the midst of a very fast total collapse to under $2 as pretty much all industrial and commodity stocks had the bottom fall out … so to be fair, everything was collapsing at the time and a couple months later, with the shares around $3, she reiterated that she thought the stock was headed to $20 again and she personally held shares).

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So what do you think? Ready to bet on a downtrodden scrap recycler and bet on continued demand from Asia, or do steel companies give you pause for concern? I personally held Posco many years ago, when Korean stocks were almost all incredibly cheap, and made a bad c