Morgan Stanley Downgrades On RSPT Hangover

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

By Rudi Filapek-Vandyck

FNArena has discovered we accidentally mixed up Bank of America and UBS yesterday when we reported the latter had lifted gold price forecasts for this year and the next two, which incidentally led to a recommendation upgrade for Avoca ((AVO)). The broker that should have been linked to this information was BA-ML, not UBS.

We sincerely apologise for any confusion caused and hope that most of our readers agree this is a rather uncharacteristic error which hopefully will never be repeated.

A lot has been said and written about the Rudd-government's idea of a Resources Super Profits Tax (RSPT), and a lot more will be written and said before the concept will make it into law, if ever.

Some anti-RSPT commentators are going as far as to put a direct link between Australia's relative outperformance this year vis-a-vis equity markets in Europe and the US and the shock Australia's RSPT announcement caused throughout the international investment community.

Expect the subject to rise above the daily market noise again now that resources analysts at Morgan Stanley have reviewed their price forecasts and valuations for all mining companies in Australia.

Morgan Stanley analysts have been among the more vocal critics of the RSPT concept from day one as their view has been, and still is, that such a concept will force miners into less optimal usages of cash, and thus to sub-optimal valuations for their shares on the stockmarket.

Prior to the shock RSPT announcement, the analysts had estimated that, given confidence would rise throughout the sector as the global economic recovery would become more solid, miners would look to leverage their balance sheets by up to 20%.

Now that a potential implementation of the RSPT is hanging in front of the sector, this is highly unlikely to happen, say the analysts. They suspect those miners with loose cash at hand will try to hoard it for future expansions. Investors may well forget all about leveraging balance sheets and the likes; it aint gonna happen as long as that RSPT remains a possibility.

With capital returns now in doubt, plus some revisions to price forecasts (down for aluminium and zinc), the analysts have remodeled and recalculated their valuations for Australian materials stocks.

Among the major changes that have resulted from this exercise are a rating upgrade to Fortescue Metals ((FMG)) to Overweight and rating downgrades for Equinox ((EQN)) and Iluka ((ILU)) to Equal-Weight. Alumina Ltd ((AWC)), Gloucester Coal ((GCL)) and Riversdale Mining ((RIV)) have been downgraded to Underweight.

The sector rating for resources in general has remained Attractive. (Note: Morgan Stanley's rating system for stocks consists of a sector rating and of a rating for each stock individually).

The likes of Minara ((MRE)), PanAust ((PNA)) and Western Areas ((WSA)) saw fairly big drops in valuations/price targets.

Morgan Stanley's preferred investment ideas in the sector are PanAust ((PNA)), Western Areas, Centennial Coal (CEY)), Newcrest Mining ((NCM)) and Ivanhoe Australia (IVA)). Stocks that should be avoided, in the stockbroker's view, include Alumina Ltd, Gloucester Coal and Riversdale; all three just received a recommendation downgrade.

Resources analysts at Citi in London believe the market is placing too much of a discount on shares for major resources companies. The current relative discount has been calculated at some 30%. But aren't earnings expectations too high? Yes, say the analysts, but still.

On their calculations, and with current spot prices as a guide, the real discount is probably closer to 15%, acknowledge the analysts, but that's still regarded as way too much given the earnings outlook is actually far from bad.

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