FYI | Mar 28 2007
Ever since the interim reporting season in February, JP Morgan strategist Martin Duncan has been telling the broker’s clientele earnings momentum in Australia is in decline.
Duncan’s point of reference is the fact the relative percentage of positive earnings revisions by local securities analysts has fallen to 45% post February while the three year average lies above 50%.
Time for the blonde public prosecutor again: all stories have two sides, sometimes even more (see last week’s editorial).
The JP Morgan strategist points out correctly that earnings forecast revisions for companies in the mining & exploration sector are making the difference between this year and the previous three.
The key question is, however, whether this genuinely signals a loss of positive momentum for the local market as a whole (as advocated by JP Morgan) or merely a case of securities analysts having yet to catch up with their commodity price forecasts? Certainly, recent developments suggest at least some support for scenario number two.
A report published this week by quantitative analysts at GSJB Were also supports thesis number two. Contrary to JP Morgan’s findings, analysts Rob Pinnuck and Alistaire Paterson report the positive bias to earnings revision in the Australian share market “continues unabated”.
As one would have expected, it partly boils down to what one’s expectations are regarding base metals and commodities in general. GSJB Were has remained on the positive side and this is reflected in the broker’s market view, leading to the quantitative department expecting Financials, Healthcare and Materials to enjoy further positive earnings revisions in the weeks, possibly months ahead.
The view that the market will have to catch up once again with better than expected pricing conditions for most commodities was repeated by the broker’s resources specialists who have just returned from another visit to China.
The commodities specialists returned with a view that iron ore prices are likely to climb in each of the next two years, that the market for zinc is less supportive than previously anticipated, but above all that the broker’s above-market price forecast for copper can remain untouched.
Time for the devil’s advocate to point out that given the importance of copper for the two heavyweights Rio Tinto (RIO) and BHP Billiton (BHP) in the local market this in itself could well push the balance into positive territory again. And that’s without taking into account that many companies of smaller size, such as Oxiana Resources (OXR) and Newcrest Mining (NCM), have a large leverage to the red metal as well.
On GSJB Were’s assumption, spot copper will average US314c/lb this calendar year. Most price projections by other experts start with a 2. If GSJBW is correct, any catch up by the market will be “significant”, if not “substantial” (or whatever superlative term one wants to throw in).
To illustrate the importance of GSJB Were’s confidence in its forecasts: the average copper spot price to date is around US266c/lb.
Canadian experts at BMO Nesbitt Burns, also bullish on copper, recently updated their forecasts as well. BMO projects an average copper price of US270c/lb this year, while conceding the figure might turn out to be conservative.
From ABN Amro, to Deutsche Bank, to Macquarie, to Citigroup (and many others): most experts have seen the need to reduce the gap between spot prices and their forecasts in recent weeks. It’s something investors in the sector must have gotten used to by now. Seldom, as might be the case with GSJBW and BMO (we don’t know yet), have analysts run ahead of reality during the past four years.
The same principle applies to uranium, where JP Morgan has mimmicked GSJBW on copper by raising its long term price forecast to US$70/lb and this year’s price average to US$90/lb. This was done last year already, many months before Deutsche Bank caught up with a 2007 average price forecast of US$93/lb and GSJBW put forward a bullish scenario that could possibly see spot uranium average US$110/lb this year. One might logically expect that in the light of recent developments (spot U3O8 is already averaging US$86/lb this year) the broker is simply waiting for the opportune moment to update its price forecasts.
Again, the difference between top and bottom forecasts in the market is simply stunning and one might feel inclined to question whether Citigroup analyst Alan Heap is doing his reputation, as well his employer’s, much of a favour by clinging on to a uranium price forecast of US$70/lb for 2007. Next year’s currently stands at US$50/lb.
Let’s face it, investors who’ve ignored the laggards among the experts over the past few years have done well, very well, even post May 2006. This does not take away the fact that ultimately the market will arrive at a turning point after which this is no longer automatically the case.
We had another good look into the uranium sector last week. Parts of our insights were published in our latest feature story “Is There Value Left In The Uranium Sector?” (See Sell&Buy-ology, 27/03/2007). We did not explicitly put this in the feature, but our gutfeeling told us the bull story for uranium is getting tired, even though the spot price may well crack the US$100/lb level soon and even move on to higher levels after that.
One more upswing, possibly post the Labor Party’s widely anticipated change in uranium mining policy, we quietly said to ourselves, and after that it’s probably over with the unlimited big blue sky potential for the sector. Heaven forbid, we might even see some share prices starting to decline later in the year!
(We’re not dismissing all future potential, we simply think it will be much less exuberant than what we’ve seen so far).
Our suspicion was confirmed by JP Morgan analysts this morning. They must have had similar thoughts.
JP Morgan only covers Energy Resources of Australia (ERA) in the local market so the broker focused its research update completely on this one company. The update by numbers provides us with the perfect illustration why uranium producers are likely to hit the above mentioned turning point sometime this year.
On the broker’s current price forecasts of spot uranium at an average of US$90/lb for 2007 and US$86/lb for 2008, supported by a long term price forecast of US$70/lb, ERA’s net present value (NPV) reaches as far as $31 per share. With ERA’s current share price a little above $27 and spot uranium seemingly poised to do better than US$90/lb for the full year, it would seem there’s plenty of upside in the shares still (12%+ to be precise, prospective dividends included).
BUT…
Raising the average spot prices for 2007 and 2008 to US$100/lb and US$110/lb respectively would only lift ERA’s NPV to $32 and $32.65 respectively.
I think these numbers speak for themselves.
Till next week!
Your I am happy as long as my gutfeel stays in synch with the market editor,
Rudi Filapek-Vandyck
(As always supported by the Fab Three: Chris, Terry and Greg)