Australia | Sep 25 2006
By Greg Peel
Merrill Lynch resources analysts led by Vicky Binns called the sector down from June based on concerns of higher interest rates and economic slowdown, as well as China deliberately trying to slow, and commodity prices simply being overblown. In the last month both BHP Billiton (BHP) and Rio Tinto (RIO) have fallen 15% to reach Merrills’ target ranges.
Apart from overall global slowing, impacting the sector has been a much weaker US housing market. This market alone absorbs 5% of the world’s copper.
However, BHP and Rio have underperformed the copper price substantially despite delivering strong earnings and continuing with share buybacks. They have now reached price/earnings ratios of 8x for 2006, which Merrills notes is only 10% above net present value.
The second half should bring strong profit results for both companies. The analysts also note that despite slowdown fears inventories are still tight at the LME and strike risks still abound. In bulk commodities, the two miners have locked-in 12-month contracts which contribute some 30-40% of earnings.
From a technical perspective, BHP and Rio are providing strong Buy signals, says Merrills. It is a good time for a short term trade – short term, because after three years of a lucrative bull market in commodities Merrills is looking for 2007 to be a down year in the ongoing upward trend of the super cycle.
Of the nine brokers in the FN Arena database, every single one has held a Buy signal on both during the present pullback. At the same time every broker has been upgrading commodity price forecasts, but only because those forecasts always run well behind spot prices. (Hence forecasts can go up while prices come down). If analysts were to value both companies at spot price levels, both would be significantly higher.
Average target prices stand at $35.47 for BHP (43% above Friday’s close) and $97.74 for Rio (44%).