China the big winner as prices tumble

25/02/2009 - 22:00

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THERE must have been high-fives all through the halls of power in Beijing last week as government Mandarins celebrated victory over Western mining interests.

THERE must have been high-fives all through the halls of power in Beijing last week as government Mandarins celebrated victory over Western mining interests.

Only 18 months ago, things were looking decidedly dodgy for Chinese industries' access to global raw materials. Commodity prices were spiralling up and out of control and asset prices were reaching stratospheric levels.

Then, in walked Ben Bernanke and Hank Paulsen. These guys and their predecessors set up the biggest market collapse since the 1930s, opening up the door for Chinese interests to pick the eyes out of Australia's best mining assets at rock bottom prices. Hank and Ben should be made honorary Chinese citizens in recognition of the huge benefits their policies and complete incompetence have bestowed on the Chinese economy.

Chinese leadership has the luxury of being able to think and plan long term. Buying OZ Minerals for 20 per cent of the price it was trading at 18 months ago and picking up interests in the local iron ore industry have set Chinese industry up with a source of raw materials supply for decades to come.

Chinalco is seeking a direct stake in Rio Tinto's Pilbara iron ore projects for $US5.15 billion. These are the latest in a string of deals whereby Chinese entities have taken strategic holdings in a raft of mining companies, including Gindalbie Metals, Mt Gibson Iron, Grange Resources and Perilya. There is also the growing greenfield interests of groups such as Citic Pacific, which is investing $5 billion in an iron project near Cape Preston.

Briefcase believes one critical area of interest for China is energy. The next move by China is almost certainly into LNG and oil production in Australian waters. Stocks such as Nexus Energy would provide a solid base for growth in this sector, while Tap Oil and Roc Oil hold potential in that area as well. But why stop there? Oil Search has huge gas reserves, while Woodside might be a political hot potato, at which the Chinese leadership might balk.

When the Chinese Premier Hu visited Perth last year, he had his pilot take the scenic route over Western Australia. Briefcase saw the big white Jumbo flying sedately over the city and felt that the premier, looking out the window, must have already decided that 'Yes, we will buy it'.

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Corporate reporting season is reaching a crescendo. The last-minute rush of reports will include a few gems, but mostly the dogs and poorer results from smaller companies. Looking through the stocks that have reported so far, along with a few others still to report, there are some opportunities for investors. Some companies have been savagely treated by the market after announcing minor downgrades, while others, which have come to the market for new equity and were initially treated harshly, have recovered magnificently. A new issue was offered in Wesfarmers at $13.50, and the stock recently traded over $17 per share. Newcrest made a placement at $27 and the stock now trades at more than $36 per share, thanks to a surge in the gold price which looks set to triple the company's profitability, compared with the half just completed. On the same theme, Transfield made an issue at $1.25 and now trades close to $2 per share.

Profit results from United Group and Monadelphous prove that you can make money as an engineer. Strong results from both engineering companies reflect a steady underlying level of activity during the December 2008 half-year period and the impact of the global financial crisis on asset values. Operating cash flows were strong, but asset values have been pared back. These two results, along with a strong result from mobile home maker Fleetwood, hold out hope for others in the sector, including RCR Tomlinson.

Interestingly, RCR Tomlinson refuses to say that there is anything wrong with its balance sheet or expected profit results, despite its share price having plummeted and receiving a 'please explain' note from the ASX. RCR presently has a market capitalisation of $42 million, yet its net tangible asset (NTA) backing, including a pile of property owned by the group, adds up to a value of $93 million.

RCR trades at less than half its asset backing, which is most unusual for such a company where a multiple of three times NTA is more normal.

Things are in flux at RCR Tomlinson. Its new chief executive is likely to want to stamp his authority on the company's balance sheet, so despite the company's protestation that its assets are not impaired, analysts will rightly expect some asset write downs either this month or in August 2009.

The company is on track to record revenue of around $600 million for the full year to June 30 2009, from which it would normally be able to achieve earnings of $24 million, or 19 cents per share if all is going well.

This year started badly for one of RCR's divisions, so the result is more likely to end up at around 10-12 cents per share, prior to any asset write-downs or sales. Briefcase sees value in the stock at 34 cents since this is less than half its NTA. The company should have a running earnings rate of closer to 20 cents per share, once it beds down newly acquired operations. Debt servicing should be comfortable, despite a surge in debt-funded acquisitions at the top of the market in 2007-08.

A new direction from its experienced new CEO is also likely to add value and improve earnings. This is definitely one to watch, as is Macmahon, whose net asset backing per share is 41 cents, compared with its recent price of 31 cents. While earnings will certainly come under pressure this year, the stocks are in good shape and there will be a time to buy.

Cement manufacturer Adelaide Brighton reported earnings of 22 cents per share and a dividend of 15 cents per share, placing the stock on an historical price to earnings ratio of just 7.4 times and a yield of 9 per cent fully franked.

Adelaide Brighton's gearing has risen to 55.3 per cent on the back of acquisitions, but its finance expense is covered five times by operating cash flow, prior to interest costs. The company expects a downturn in activity, but can cut its costs to match. This is an excellent company and even allowing for a fall in earnings, represents a bargain basement opportunity.

Macquarie Office Trust suffers because of its name and association. Trading at 15 cents, the unit price represents less than 20 per cent of the stated net tangible asset backing of over 60 cents per unit, with gearing down to a manageable 37.5 per cent. Even as its asset prices are pared back further during 2009, which seems most likely, this trust will remain strongly cash-flow positive, with management predicting earnings per unit of around 4.3 cents for a full year and distributions of 0.75 cents per unit each quarter, placing the stock on a prospective price to earnings of 3.5 times and a yield of 20 per cent. Am I missing something here, other than everyone distrusts Macquarie, or are the units really worth 40 cents?

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In the energy sector, even more anomalies can be found. Cooper Energy generates a strong operating cash flow from oil production operations with sales of around $35 million per year. Remarkably, the company trades with a market capitalisation of $80 million, yet is holds $88 million of cash and has about 2 million barrels of oil reserves, which Briefcase thinks could be sold tomorrow for at least $40 million. Basically, Cooper is trading at less than half its true value, only because the market does not see a buyer who would be interested in making a bid.

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Rural property owner, Primeag, trades at a large discount to its asset backing and in this case, there is a very good reason for the discount. The company sits on net cash of about $22 million or 14.5 cents per share, which when added to its property assets, tallies up to a value of $1.90 per share, yet its shares trade at just $1.08 each on the market. Primeag is not making much of a profit and is unlikely to pay a large dividend.

Rural assets are lucky to return 5 per cent a year, so the company might target profits of around $14.5 million or 10 cents per share, when the weather is ok and the cows don't run away.

Briefcase sees a rather positive outlook for food production companies as rising wealth levels in Asia result in increased demand for meat and grains. Primeag has secured a portfolio of properties in well-watered parts on north-eastern NSW and south-eastern Queensland where it has sufficient water to grow a variety of grains plus cotton, as well as fattening beef cattle. When commodity prices improve, most likely into 2010, Primeag will harvest its rewards, in the meantime, investors can take comfort in the fact that there is no more prime agricultural land being made and the shares trade at about 57 per cent of their asset backing.

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Cash box come asset manager, MMC Contrarian trades with a market capitalisation of $55 million, yet it has net assets of $102 million, of which cash alone is $79 million. The company's share price is 39.5 cents, yet its net asset backing is 73 cents, including 57 cents per share of cash. The market must believe that management is about to abscond with the funds or that they will spend it on some useless endeavour. Briefcase believes that this is unlikely, given that conservative interests have recently taken control of the company, which is now ideally placed to pick up assets through 2009.

n Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au

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