19/07/2005 - 22:00

Tim Treadgold: Briefcase - Speculation continues over ‘super-cycle’

19/07/2005 - 22:00

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The biggest guessing game on the Australian stock market today is whether we are, or are not, in a ‘super-cycle’, a prolonged period of rising commodity prices.

The biggest guessing game on the Australian stock market today is whether we are, or are not, in a ‘super-cycle’, a prolonged period of rising commodity prices. A quick survey of resource company share prices shows that most investors are non-believers.

This conclusion is not reached by peering into a crystal ball, the tool used by many high-paid financial analysts, but by looking at current share prices of a selection of leading (and not so leading) mining companies, and asking a simple question: if there is a super-cycle why are they so cheap?

BHP Billiton, for example is currently trading at around $18.55, which might seem expensive to some people. But put that number through a fundamental analysis and you’ll discover that Australia’s biggest resources company is selling on a price-to-earnings (PE) multiple of around 13.4 times. That’s assuming profit for the year ended June 30 comes in at the forecast $8.6 billion – or $US6.45 billion as BHP Billiton reports in US dollars (official results are scheduled for release on August 24).

Keep your eye on the PE factor and then roll your thinking forward a few months, and look at the current year’s forecast profit of $A11.15 billion ($US8.36 billion). If that estimate from the consensus of 15 world-class stockbroking firms is right, then the PE ratio drops to 10.1 times; remarkably low for a business of the quality of BHP Billiton and a measure of the discount being applied by the non-believers, investors who think commodity prices have peaked and will soon fall.

Briefcase, as it warns repeatedly, is not allowed to give investment advice, but it’s easy for any novice investor to run the numbers for themselves. Rather than pricing BHP Billiton on the discounted PE of 10.1, try applying the 13.4 PE. To do this you need the earnings-per-share (EPS) numbers, which are $A1.38 for the year just ended and $A1.84 for the current year.

Dividing the $A1.38 into the current share price of $A18.55 produces the PE of 13.4. Dividing the forecast earnings of $A1.84 into the current share price produces the forecast PE of 10.1.

Shifting into reverse, see what BHP Billiton’s share price would be (theoretically, of course, and this is not investment advice) if the forecast earnings of $1.84 are multiplied by the current PE of 13.4 – yep, a share price of $24.65, or are rather attractive $6.10 (33 per cent) more than the latest price.

Before anyone dashes off a letter and complains about how simplistic these calculations are, remember that the purpose of the exercise is not to probe the relative merits of an investment in BHP Billiton. Rather, it was asking whether the market believed in the ‘stronger-for-longer’ argument about commodity prices, the so-called super cycle.

Rio Tinto is another example of a stock apparently being discounted because investors do not believe that the current season of record-breaking profits flowing from record-breaking commodity prices can be maintained. It is trading around $46.42, which translates to a PE of 10.6 times this year’s numbers (Rio Tinto has a December balance date), and a remarkable 9.9 times on forecast 2006 profits.

If this little trip through the world of fundamental analysis doesn’t convince you that the world is full of non-believers in the commodity-price super-cycle, then take a look at some of the second- (and third-) tier resource stocks.

Excel Coal, the tearaway NSW coal producer, is trading at $7.21, a price that seems high given it floated at $2 last year. But the price is factoring in future profits, up to a point. In the June 30 year just ended, Excel is forecast to have earned $65 million, and to be trading on a PE of a rather handsome 21.6.

This financial year, Excel is said to be on track to earn $221m, thanks to booming world coal prices, a number that boils down to a prospective PE of 6.4 – while next year’s forecast profit of $243m produces a PE of just 5.7.

Single-digit PE ratios are a sure-fire tell-tale that the market lacks confidence in either the growth prospects of a stock, or the sustainability of its future earnings, which appears to mean that investors do not believe in coal prices staying high for long.

Dip down further into the resources world, and a bit closer to home, and the numbers get even more interesting because here we find either the bargain-basement buys of the decade or even more proof that the market is being driven by non-believers in the super-cycle.

Sally Malay Mining, which has two nickel mines in production and is expected to report a profit of $20m for the year just ended has a PE of 7.4. Next year, when profit rises to a forecast $42m the PE is 3.4. Does that mean Sally Malay should be twice its current share price of 85c?

That’s one answer. Another is that the market does not believe either the sustainability of the nickel price, or Sally Malay’s long-term production outlook.

If you are a believer in the super-cycle (and Briefcase does not give cycling advice either) then it seems that right now is a fascinating time in the market because, if the earnings flow as forecast, then an entire sector is seriously under-priced.

Mincor Resources is on a prospective PE for current year earnings of 3.5. Independence Group is on 5.3, and even market darling, Consolidated Minerals, is on 8.4.

The PE numbers in the resources sector are either an opportunity, or a warning. You be the judge.

•••

NEXT time someone runs down the Australian economy, consider how we are going relative to the rest of the developed world. Believe it or not, Australia is a star.

A recent survey of economic forecasters predicted that next year, as earnings from the resources sector kick in, Australia will grow (as measured by gross domestic product) by 3.1 per cent.

Resource-rich states such as Western Australia and Queensland could double that figure, with the national average being dragged down by slow-moving Tasmania, Victoria and South Australia.

But even if someone reckons that 3.1 per cent is modest growth, try standing it alongside everyone else and you’ll find that the only country growing faster is the US, at 3.2 per cent.

In Europe, where socialist ideals retain a grip on politics, the growth rate forecasts for next year include France expanding at a sickly 1.5 per cent, Germany at a more sickly 1.3 per cent, while Italy is hardly moving at 1.1 per cent.

Little wonder that the concept of a unified Europe built on the so-called social model is in deep trouble, and that Andreas Merkel, Germany’s version of Margaret Thatcher, is the hot tip to emerge as leader of that country and kick-start a free market revolution.

•••

“If you want to get on in this world make many promises, but don’t keep them.” Napoleon Bonaparte.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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