Market still holds value propositions

02/04/2008 - 22:00


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There seems to be a competition developing amongst finance journalists, along with some economists and market analysts, to be the first to call a base to the current bear market phase on stock markets.

There seems to be a competition developing amongst finance journalists, along with some economists and market analysts, to be the first to call a base to the current bear market phase on stock markets.

Briefcase does not intend to play this dangerous game, preferring to seek out value situations amongst the total market, irrespective of its overall direction.

I don’t think that I am clever enough to declare when the overall market will bottom out, but I have a greater degree of confidence in the ability to spot stocks which have fallen to a long-term value proposition.

Over past weeks, I have pointed to several value opportunities such as Mirvac Ltd, Arc Energy Ltd and GRD Ltd, as well as Suncorp Metway Ltd, and despite volatile markets, these companies have all made small recoveries.

Ongoing buying in the market by directors of GRD Ltd, UXC Ltd, Elixir Petroleum Ltd, Horizon Oil Ltd, Havilah Resources Ltd and Boom Logistics Ltd provides further proof of emerging value, with support for these companies having fallen to levels where those running the shop feel compelled to spend their own hard-earned cash to buy shares.

However, the broader market still has to weather the reporting season in May.

Briefcase still sees potential for the All Ordinaries Index to fall towards 4,750 points, but given the value apparent in many financial and building stocks, it believes that this fall will only happen if confidence in the outlook for resource stocks declines, taking the major mining companies to lower levels.

So far, commodity prices have held up, if not lifted in US dollar terms, as that currency continues its slippery slide.

In time, weaker economic growth in North America, and possible shrinkage of the US economy as recession takes hold, are likely to lead to medium term commodity price weakness into 2009, which would impact on earnings expectations for the miners.

I am probably too far along the curve on this prediction, with markets now focused on near term issues, such as interest rates and short term activity in China.

But taking a longer term view, and after looking at forecast supply and demand balances, there is potential for sector weakness.

In the longer term, looking out past 2010, there is no doubt that raw material suppliers, such as BHP Billiton and Rio Tinto, will be in very strong positions, achieving higher real term prices for metals and industrial minerals.

But my concern is for the impact of medium term economic weakness in the US.

Briefcase agrees with Australia’s Reserve Bank governor that Australian banks have a far superior balance sheet position compared to their US cousins; but as customers increasingly get themselves into financial difficulty, these troubles will begin to impact on the quality of local bank’s lending books.

A bank can only operate while there is confidence in its ability to lend prudently and manage its portfolio.

A loss of confidence can bring down any bank, because the basic banking business model involves high gearing combined with a level of confidence, often maintained by the establishment of fall back finance security from either an industry regulatory body or a government.

The failure of the UK’s Northern Rock bank and its subsequent nationalisation is a case in point.

To illustrate how this works, recent market rumours in the UK sent one of its largest financial institutions and owner of Bank West, HBOS plc, into a tailspin, with the company trading down to an historical price to earnings ratio of just four times.

Every bank relies on market confidence for survival.

Once this is lost, funding dries up and it becomes difficult to run the operation.

What we see now in the US is its Federal Reserve Bank acting with Federal Treasury as a backstop to banks that have acted imprudently.

A re-focus on lending quality and tight liquidity ratios may result in much reduced levels of credit availability for the rest of 2008, which will impact on the ability of businesses to grow their activities, putting pressure on corporate earnings into 2009.

••• The US housing market has entered a capitulation phase, while Australia’s market looks to be running about 12 months behind on a similar cycle.

Sales of existing (versus new) homes in the US rose to an annual rate of 5.03 million in February, a 2.9 per cent increase from January’s unrevised 4.89 million annual rate, but year on year sales were down 24 per cent from February 2007, reflecting the dire state of the US housing market.

The median US home price was $195,900 in February, down a whopping 8.2 per cent from $213,500 in February 2007.

This price fall was the largest on record.

Briefcase sees these numbers as representing a capitulation by sellers, who are now happy to take a much smaller price in the current economic environment.

Homebuyers in the US are now able to pick up housing at very affordable prices.

However, once the current crop of eager buyers is satisfied, sales are likely to stall again as new, less willing buyers wait on the sidelines for further price falls.

This pattern is likely to be repeated in Australia as a rush of new housing stock onto the market creates a glut, which will force prices lower.

Local pentup demand will initially lead to home sales increasing at lower price levels, but falling house prices and rising finance costs will encourage would-be buyers to step back and wait for lower prices as 2008 rolls on.

Locally, we have witnessed a huge rise in the stock of dwellings on the market, with unsold units in Perth rising from around 4,800 to more than 16,000 over the past two years.

In previous columns, Briefcase has pointed to a rapid growth of ‘For Sale’ signs around the suburbs, but the story gets worse.

Many houses now on the market do not have signs out the front.

While listings expand the property sections of our local papers, real estate agents figure that it is a bad look if every fifth or sixth house in the street has a ‘For Sale’ sign.

So properties are now listed, but the market is not cluttered with billboards proclaiming the fact.

There can be no doubt that the dual impact of higher finance costs and increased supply will push the cost of houses down in Australia as 2008 unfolds.

••• Following on from our theme of watching on-market director buying, it is pleasing to note that the managing director and two other directors of local diesel to gas conversion company, Advanced Engine Components Ltd, have been wading into the market to pick up some cheap stock during the recent price weakness.

This is a great effort.

Putting their money where their mouth is shows strong support for the business in the best way possible.

Briefcase calculates that ACE is still running with a small operating cash flow deficit, but could just become cash flow positive by midyear.

The company has a number of initiatives on the go, which could lead to strong sales of its Natural Gas Vehicle Systems in several Asian markets, where gas prices and a drive to use cleaner fuels supports ACE’s technology.

The company is in the right place at the right time to profit from its excellent, clean and green technology for bus and truck engines.

Elixir Petroleum Ltd’s chairman has also boldly entered the market, picking up a lazy 250,000 shares at a bargain basement price.

Elixir has established an operating cash flow of about $900,000 per month from gas production in the Gulf of Mexico which supports exploration efforts in the UK North Sea and offshore Sierra Leone, where Briefcase calculates that an oil discovery would be worth over $4 per share.

Meanwhile, Havilah Ltd’s directors, who were seen in the market last week, have continued to chip away at bargain basement levels.

The managing director of another successful Gulf of Mexico gas producer and exploration company, Texon Petroleum Ltd, has also been seen in the market picking up cheap shares at close to 40 cents, when Briefcase values the company at closer $1 per share.

Luckily for him, the price has now jumped to over 50 cents, rewarding his persistence.

• Peter Strachan is the author of subscription-based analyst brief StockAnalysis.

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