Rudi On Thursday

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

In my Weekly Analysis this week I mentioned a change in market
leadership that is taking place in the Australian share market. In a
not too distant future the banks will no longer be the most important
group of companies in the share market, and the former Kings of Bridge
Street will have to learn how to live in the shadows of the new numbers
one: resources stocks.

That conclusion was based upon the fact that the relative
representation of the banks in Australia’s leading share market indices
has been in gradual decline over the past few years
while resources, spearheaded by BHP Billiton ((BHP)) and Rio
Tinto ((RIO)), have rapidly grown in relative importance. At
respectively 17%, and falling, and 15%, and rising, it doesn’t take a
genius to figure out there will come a point when the rising resources
will meet the falling banks on their continuous climb upwards. Given
the trend so far in 2008, that moment does not seem to be too far away.

But that’s based upon both sectors’ relative weight in the major
indices. If you look at the share price valuations for both sectors,
then the switch has already taken place. When was the last time
you remember Price/Earnings ratios for banking stocks were
lower than for resources?

Wasn’t that always the key complaint from resources bulls, that
investors would not ascribe enough value to miners because
securities analysts kept on assuming the good times would only last for
so long?

Well, in March 2008 the differences between both sectors
are significant. While the current market average PE lies
between 13 and 14.5 (depending on one’s definition of “the market” and
on whose estimates) most resources stocks are currently trading on a
multiple above that, while the banks barely manage to hold on to PEs of
10 (that becomes 8-something if you look further into the next fiscal
year).

Remember when the banks were on 15 and BHP on ten? That was early 2007.
Banks and resources have simply swapped places. What change of
leadership soon? It has already happened!

Here’s another change in leadership I discovered today:

Yes, that’s right, the dull and unattractive, some would even
say “fragile” Metcash ((MTS)) has proven to be a better
investment than highflyer Harvey Norman ((HVN)) over the past six
months. And with a net difference of 20%, this is not something of a
fluke.

This is how, if you observe the markets long enough, you come to
realise that nothing is ever set in stone, and nothing stays as it is
for ever. The laggards of yesteryear are in essence the champions of
tomorrow, and what’s holding back one company today can turn into its
benefit tomorrow.

Mind you, the chart doesn’t show but Metcash shares still lost
a little over 10% over the past six months. Harvey Norman lost
considerably more, but that was because investors got excited about
sales prospects of iPods and Xboxes and Windows Vista. Harvey Norman,
just like JB Hi-Fi ((JBH)), was arguably trading at lofty
valuation multiples, and as I pointed out over the past few weeks:
nothing is as damaging as contracting PEs when investors head for the
exits.

But there’s also another reason why the leadership is shifting in the
retail sector: as investors are coming to terms with the fact that the
Australian economy is slowing, they are looking into the finer details
of what this actually means. And while they’re analysing the outlook
for Australia over the next few years, it’s not that difficult to see
they will come to the conclusion that not every part of Australia is
the same. There are strong regional differences in that Queensland and
Western Australia -both mining regions- will likely perform stronger
during the downturn than New South Wales and Victoria.

Could it be that this perspective is already being reflected in
investor’s choices among retailers?

A report by Citigroup this week certainly seems to suggest this is the
case. On the broker’s assessment, Metcash ((MTS)) -see chart above- is
the most leveraged of all retailers in Australia to the Queensland and
WA states. Current consensus estimates believe the company will achieve
double digit EPS growth both this year and next year. And the
market feels relatively certain this is achievable because there would
be no PE ratios of 15.9 (FY08) and 14.3 (FY09) otherwise.

But guess what? Citigroup believes second behind Metcash comes Harvey
Norman ((HVN)), followed by Woolworths ((WOW)).

There’s also another reason why Metcash stands out among retailers.
Farmers are expected to have a bumper year ahead as rain has finally
replaced drought. Guess which retailer is best placed to benefit from
this? (the one in red on the chart above)

Metcash shares don’t rate that high on the FNArena Sentiment Indicator,
though still a positive 0.3 -for some reason JP Morgan continues to
dislike the stock-  but dividend yield is currently estimated
at 4.7% for this year and 5% for next. The average price target
suggests there is about 17.5% upside left in share price potential.

What all this means in effect is that Metcash is trading on lower PE
multiples than most others in the sector, with a higher dividend yield
and the best leverage to the two strongest regions in the country, plus
a free bonus from a resurgent farmer community. It’s not really
difficult figuring out why the former prince of dull-ness is suddenly
holding the scepter amongst all retailers, is it?

(If you want to further investigate this change of leadership don’t
compare over a six months period like I did with Harvey Norman in the
chart above. This change is relatively fresh and will only show up on
most charts of three months or shorter.)

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Sophia, Greg, Chris, Paula, Grahame,
Pat, George and Joyce)

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