Take Out BHP, And What Have You Got?

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            [0] => ((BHP))
            [1] => ((NCM))
            [2] => ((RIO))
            [3] => ((WPL))
            [4] => ((LGL))
            [5] => ((FMG))
            [6] => ((LEI))
            [7] => ((WOR))
        )

    [1] => Array
        (
            [0] => BHP
            [1] => NCM
            [2] => RIO
            [3] => WPL
            [4] => LGL
            [5] => FMG
            [6] => LEI
            [7] => WOR
        )

)

This story features BHP GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: BHP
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The share price of BHP Billiton ((BHP)) has risen 27% since July 1, which has provided no less then 55% of the rise in the index over the period, notes Macquarie. It is a long way down to Newcrest’s ((NCM)) 5.9% influence. Rio Tinto ((RIO)) provides 5.1%, Woodside ((WPL)) 4.1%, Lihir ((LGL)) 3.6%, Fortescue ((FMG)) 3.2%, Leighton ((LEI)) 2.9% and WorleyParsons ((WOR)) 2.4%.

Those eight stocks account for 82.2% of the market’s return this financial year.

If you lump mining services provider Worley with the others, this means construction company Leighton is the only non-resource stock to provide a notable contribution to the Australian market’s foray into blue sky territory (though there is a clear link through the many services it provides to the industry). Indeed, half the stocks in the ASX 200 have contributed minus 50% to the total return. 34 stocks have contributed +114%. By contrast, the distribution of returns across the index for FY07 was far more “normal”.

The implication, Macquarie notes, is that such a narrow distribution of returns can lead to strong outperformance, and strong underperformance. Currently we have outperformance as investors factor in significant earnings upgrade expectations in the resource sector. Analysts have been forced to yet again upgrade their commodity price forecasts, particularly for iron ore.

Hence we have seen forward price/earnings ratios advancing into overstretched territory. Industrials are still trading well above their long term (1990 forward) average, Macquarie suggests, and now the resource sector is chiming in. During FY07 the industrial and property trust sectors helped to drive multiple expansion, but since the credit crunch these have now fallen away.

The increase in PEs has also come to JP Morgan’s attention. The analysts note the overall market is now trading on a one year forward multiple of 16.3x, which is the highest level since May 2002. Industrials ex-resources are trading at 16.6x against the long term average of 14.8x. Resources are trading at 15.8x, up from 13.6x at the end of August and above their long term 15.6x average for the first time since February 2004.

Breaking down the Industrials, JP Morgan suggests “pure” industrials are trading at 18.7x, property at 18.2x, non-bank financials at 15.2x, and banks at 13.9x. The conclusion? Overweight banks. Steer clear of pure industrials and property.

JP Morgan also suggests the market will begin to switch out of overpriced resource stocks into banks. This is despite JPM’s bank analyst team being the most sceptical in the market with regards to post-crunch banking sector performance. But while the bank analysts are sector specific, the strategists are looking at relative returns.

As PEs have been rising along with prices, the obvious conclusion is that E hasn’t followed P. This is confirmed by Macquarie’s assessment of earnings revisions post the reporting season. Averaging out the Macquarie analysts earnings up/downgrades arrives at a figure of very close to 100%. In other words, the net change is nearly zero. Prices are being driven not by upgrades to expected earnings, but by expected upgrades to expected earnings. The greatest expectation lies in the iron ore market, where annual price negotiations are about to begin and price increases of 50% or more would not surprise.

That’s why BHP, Rio and yet-to-deliver-anything Fortescue have been so influential. In BHP’s case, there’s also oil (which has also seen price upgrades across the globe) and gold (ditto) and Olympic Dam in general with all its uranium and copper to boot. All we need now is for reality to catch up to the BHP share price – one way or the other.

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