My goodness! You can’t fault FTSE 100 steel and coal producer Evraz (LSE: EVR) on its tasty-looking quality, value and momentum indicators. Right now, the firm looks like something of a super stock, and that forward dividend yield in excess of 8% is enough to tempt even the most hard-nosed of seasoned investors.
Beware of the tempting valuation
The shares are up more than 5% today, as I write, on the release of the third-quarter trading statement. However, since early 2016, the rise has been about 800%, which to my mind qualifies the stock as one of those millionaire-makers we keep talking about at the Fool. Yet despite today’s gargantuan dividend yield, I don’t think you’d have scored that investment gain by taking a dividend-led approach to picking the stock. Indeed, back in 2016, Evraz wasn’t even paying a dividend, earnings were on the floor, and the price-to-earnings ratio was high compared to today.
So, should we be investing in Evraz today, based on its low valuation and its high dividend yield? I think there’s a strong clue in what happened before when the valuation was high and the yield was zero – the shares shot up as the business recovered in what looks like a cyclical up-leg.
Maybe now that the valuation indicators have reversed, we could see a cyclical down-leg next, with falling earnings, a plunging share price, and a vanishing dividend. Maybe, and maybe not, but I’m reluctant to take the risk, and I certainly wouldn’t view Evraz as a dividend-led investment now. It’s a cyclical through-and-through, and the investing rules for cyclicals are different.
A mixed bag
The company said in today’s report that compared to the previous quarter, consolidated crude steel output fell by 10.3% “primarily due to lower pig iron production,” which also led to a 0.7% decline in sales of semi-finished goods. Lower sales of railway and flat-rolled products led to a 1.2% slide in finished goods. Something like 80% of the company’s revenue comes from its steel business, so those numbers are important.
Meanwhile, production of raw coking coal climbed 9.6%, and coking coal product sales eased back by 8.3%. External iron ore product sales fell by almost 16%, and sales of vanadium products fell by 3.9%.
The results are a bit of a mixed bag, but the over-riding consideration is that Evraz is hostage to the supply-and-demand dynamics of the commodity market. Commodity prices can rise and fall and, with them, the profits of producers such as Evraz rise and fall too. That’s why, after a period of high earnings, I reckon Evraz looks risky.
City analysts following the firm have pencilled in a hefty reduction in revenue and earnings for 2019, so I think the positive cyclical trade with Evraz is behind us, and at these levels, the downside risk outweighs the upside potential for investors.
However, today’s stock market weakness strikes me as a golden opportunity. But instead of taking on single-company risk with Evraz, I think conditions are perfect for beginning a strategy of dripping regular payments into an FTSE 100 index tracker fund.
