Rudi On Thursday

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

(This story was originally published on Wednesday, 30th September. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

Your editor is spending more time in the air and on the road these days than behind his desk. After a presentation in Sydney’s northern suburbs on Monday, I will be at the Trading and Investing Expo in Melbourne on Friday and Saturday. Next week I will visit Perth for another presentation. Members and readers who happen to be in the neighbourhood, do come over and say hello – for details see the bottom of this week’s editorial.

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I heard the journalist inside me exclaim today: “let’s hope we get a correction”. Not only does the expert community persist in their calls that one is necessary (to enable them to get back in at cheaper prices, a cynic would comment), but colleagues at Sky Business program Market Moves released the results of their expert survey today. The outcome was that market consensus sees the S&P200 index end the year somewhere around 4870 – grosso modo a hundred and fifty points higher than where the index closed at today.

The new year is still more than 90 days away. That’s not really an exciting prospect? It implies we will again miss out on the traditional Christmas rally this year, which would make for misses three years in a row. Unless, of course, we have a correction first.

There is, on the flipside, plenty of room for alternative scenarios. Some chartists, including our own TechWizard, don’t believe the much talked about correction will happen – as in: not at all. The common view is then that the share market will finish the year higher than where it is today, just without any noticeable pullback in between.

(One would assume the index under such a scenario would gain more than the aforementioned 150 points, but it doesn’t necessarily have to).

There are other factors that can push share prices higher from here, but let’s first mention the all-important factor that has gone missing these past few weeks: valuation.

I have noticed almost nobody mentions descriptions such as “cheap valuations” or “undervalued” any more. Those among you who have the habit of reading my Weekly Insights and Rudi On Thursday editorials will remember how I started mentioning “full-er valuations” in August and earlier this month.

I note, for instance, that BHP Billiton ((BHP)) shares are back below $37 while they seemed to be going for $40 not that long ago. Shares in CommBank ((CBA)), however, have continued surging and they are again nearly 8% above their average price target.

The story behind these two market leaders shows us the division in the market. Conclusion: this still can go either way.

Two factors are, according to my observation, most often mentioned as reasons why this market can still go higher and faster than the above mentioned expert survey suggests. One is that many fund managers are still holding a relatively high amount in cash or bonds, and they are under enormous peer pressure to change this.

I am sure you’ve heard this one before: from the moment these managers decide to finally give up on waiting for the correction, and start buying shares, this market could easily see another leg up. The next problem, of course, would likely become one of an even full-er market valuation. This would ultimately make that elusive correction more likely to happen. That, however, would be a problem for later, somewhere in 2010 one would assume.

(As long as the uptrend remains intact this would remain a minor problem overall).

The second reason is more cycle specific. Coming out of the deepest trough in this global downturn, overall confidence amongst CEOs and inside company board rooms is improving and many of the people involved wish they were in a much stronger position today. Unlucky for some of them, other companies are in a relatively strong position, and as confidence is being restored, they will be trying to lock in some of the available benefits.

In other words: corporate acquisitions. Stronger fish with sharper teeth will be snapping away at the weaker targets. We have seen already the first signals appearing across the globe. Think ANZ Bank ((ANZ)) in Australia.

Markets always get very excited about this, as again witnessed in the US this week. As seen in the LNG space in Australia, it only takes one or two deals coming through and the whole sector is being pushed to higher multiples. In the end, however, investors will find that in the longer run most corporate acquisitions don’t work out very well.

Remember all the brouhaha when Foster’s bought Southcorp? Or when Babcock & Brown bought Alinta? Rio Tinto and Alcan?

In most cases it turns out the buyer paid too high a price, or the expected synergies prove too ambitious.

What makes investors think this time will be different? Well, maybe because we’re only just coming out of the economic trough, and asset prices have likely further to rise, so the success rate of corporate acquisitions might turn out better than before the downturn?

RBS Australia, on Wednesday, released a report arguing the degearing of corporate balance sheets in Australia during the crisis has set up many top companies for a spending spree in the six to eighteen months ahead. Some of these companies will spend most of it internally, to boost growth from existing operations and assets. This group, believes RBS, includes the likes of David Jones ((DJS)), Wesfarmers ((WES)) and Energy Resources of Australia ((ERA)).

A second group will be looking to acquire offshore. RBS believes this group includes the likes of News Corp ((NWS)), WorleyParsons ((WOR)), Toll Holdings ((TOL)), BHP Billiton ((BHP)), OZ Minerals ((OZL)) and Paladin Energy ((PDN)).

Whether investors and shareholders in these companies draw extra benefits from this will be largely determined by how these plans will be executed.

There is a third group of likely spenders that might inject more excitement into the market, as these companies are believed to be on the prowl for local targets. RBS has identified Crown ((CWN)) as a potential buyer of Tabcorp’s ((TAH)) casino assets. Also, Tatts ((TTS)) may well take a shot at NSW Lotteries, suggests RBS.

In the retail space, Metcash ((MTS)) is believed to be in the market for smaller bolt-on purchases, while Origin ((ORG)) and AGL Energy ((AGK)) are in the running for soon to be privatised NSW electricity assets.

Some companies, let’s call them group number four, might use their financial strength in yet another way. RBS suggests Ansell ((ANN)) might decide to do another share buy back, while Primary Health ((PRY)) is likely to increase its dividend.

Analysts at JP Morgan added their own candidates to the list. JP Morgan notes various companies have recently indicated they would like to go shopping. These companies include Abacus Property Group ((ABP)), Atlas Iron ((AGO)), ANZ Bank, Healthscope ((HSP)), Lihir Gold ((LGL)), Macarthur Coal ((MCC)) and Westfield ((WDC)).

More importantly, maybe, JP Morgan analysts have identified the following companies as potential take-over targets: AXA Asia Pacific ((AXA)), Caltex ((CTX)), Lend Lease ((LLC)), Macquarie Infra ((MIG)), Macquarie Office ((MOF)), Perpetual ((PPT)), Tabcorp Holdings (see also Crown above) and -believe it or not- Wesfarmers ((WES)).

Other companies that could well end up on someone else’s shopping list, JP Morgan believes, include Alumina Ltd ((AWC)), Suncorp-Metway ((SUN)), Bendigo and Adelaide Bank ((BEN)), Seven ((SEV)), Bank of Queensland ((BOQ)), Australian Pharma ((API)), Cudeco ((CDU)), MEO Australia ((MEO)), Paladin Energy (see also above), Eastern Star Gas ((ESG)) and Bow Energy ((BOW)).

All these companies are -one way or another- considered under priced and thus they could represent easy added-value to a suitor.

When it comes to a pure value proposition, JP Morgan has identified a few others that currently stand out as the cheapest on relative PERs in their respective sectors: Aditya Birla ((ABY)), Babcock & Brown Infra ((BBI)), Biota ((BTA)), Centro Properties ((CNP)), Eircom Holdings ((ERC)), Melbourne IT ((MLB)), Nexbis ((NBS)), Nido Petroleum ((NDO)), Photon ((PGA)), Service Stream ((SSM)) and Tassal ((TGR)).

To those with the right risk appetite, willing to play the game: good luck!

With these thoughts I leave you all this week,

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab Team at FNArena).

P.S. I – To those who are visiting the Trading and Investing Expo in Melbourne this week (Friday and Saturday), I will be there both days inside or near the stand of ThinkMinc with a laptop and my usual good spirits. Come over and say hello if you happen to walk past. For more info: www.tradingandinvestingexpo.com.au

P.S. II – Coming Tuesday, 6th October, I will give a live presentation for members of the Australian Investors’ Association (AIA) in Perth. Location: the Wembley Downs Tennis Courts, corner Morden and Ednah Streets, Wembley Downs. Time: from 7.30 to 9pm. Non-AIA members are welcome too.

P.S. III – Earlier in the year I promised I would look into taking my presentations to Brisbane and Melbourne, and that is exactly what my next goal will be after I return from Perth. So watch this space; more news will be forthcoming.

P.S. IV – Ord Minnett is the most bearish with a projected 4500 for the ASX200 by year end. Gary Stone of ShareFinder has positioned himself at the other end of the ledger. He sees the index at 5400 by year end. If you want to see all the details of the MarketMoves survey for yourself, you can download the excel file (see bottom left) on the following page: www.businesschannel.com.au/programs/marketmoves/

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