Australia | Sep 28 2006
By Greg Peel
“The commodity-price-driven run-up in equity prices over the past 18 months has been frantic. It has certainly been exciting but, as equity analysts, our work has been dominated by injecting ever-increasing commodity price expectations and holding on.”
This refreshing bit of analyst candour comes from Rob Clifford and his resources team at ABN Amro. FN Arena has been noting for probably two years now that resources analysts have been able to do little but keep ratcheting up commodity price forecasts in the vacuum of soaring spot prices. That such capitulation goes against everything an analyst has learnt in the past is academic – analysts cannot afford to lose clients just because copper prices aren’t doing what they should.
While there has been the odd hint of exacerbation from resources analysts, most have continued to raise prices while also warning of the cyclical nature of commodities. Never has an analyst got anywhere near forecasting prices to remain at spot levels for the longer term, and exercises in which analysts have plugged in spot prices just for the hell of it show that valuations for the likes of BHP Billiton (BHP) would be 30-40% higher.
When both commodity prices and commodity stocks ran hard up to May, notes ABN, the BHP discount to spot valuation narrowed down to 19%. Now that prices have corrected aggressively, ABN has run the simulation again to find that BHP is trading at a 46% discount. While the “discount to spot” measure is not a commonly revered indicator, ABN suggests it at least provides some further weight to the argument that BHP is looking oversold.
It was a given that BHP would fall rapidly with falling spot prices, but the question now is: how much is too much? ABN believes we are close.
The analysts concur with the view put forward by Merrill Lynch on Monday that at 8x forward multiples, it is difficult to see downside for BHP from here. They also note that in the last cycle, BHP put in a 27% retracement. So far it has come back 24% this time around, and that’s good enough for ABN.
“The value looks good, the cash flows look good and the growth looks good”, says ABN. “We believe it’s time for BHP to correct back up”.
To that end ABN “reiterates” its Buy rating (every broker in the FNA database has kept a Buy rating) and target price of $36.00. (Database average $35.47).