Earnings Risks and Stockbroker Favourites

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This story features EQUINOX RESOURCES LIMITED, and other companies.
For more info SHARE ANALYSIS: EQN

By Rudi Filapek-Vandyck

It has become a sentence we have all become too familiar with: if the Gillard government makes a few key adjustments to the proposed Resource Super Profit Tax (RSPT), share prices for miners and related companies will rally like there's no tomorrow.

The reasoning looks sound and logical, unless, of course, it turns out it isn't.

Analysts at GSJB Were, soon renamed Goldman Sachs, report this morning they cannot find any evidence that resources stocks in Australia have weakened more than their international peers. In other words: the fall from grace since April has all been macro-driven -China slowdown, US double-dip, Europe austerity- with only a little added from domestic ingredients, like the RSPT.

What this means, suggest the analysts, is that resources stocks might actually fall in the short term if news about Gillard concessions finally hits the market. The ones to buy, suggest the analysts, are the contractors as they went down with the miners in April, but they have not enjoyed a similar normalisation of share price levels since.

Meanwhile, Citi analysts Paul Brennan and Richard Schellbach have come to the conclusion that earnings risk is now 100% to the downside in Australia. This because macro-forecasts are in decline and at some point those micro-earnings forecasts simply do not match the overall macro-picture. That moment is now, suggests Citi.

Both analysts cite calendar year forecasts from Citi analysts, so the numbers look a bit different from what I have been quoting in recent analyses. As things stand, Citi analysts are forecasting earnings per share growth in the order of 18.3% for calendar 2010, to be followed up by another jump in the order of 17.6% in calendar 2011.

These numbers look a bit rich, say Brennan and Schellbach, as their recently revised macro-economic forecasts suggest numbers in the order of 14% and 10% respectively. This is probably as good a time as any to repeat one of my recent conclusions: average EPS forecasts for ASX200 companies would have to fall by some 6% to imply the share market is fairly valued at around 4500.

The numbers cited by Brennan and Schellbach suggest this certainly is but a genuine possibility.

For those readers who like to keep track on market numbers: the ASX200 is today trading on a FY10 Price-Earnings multiple of nearly 15.5, while the number on FY11 consensus estimates is in the vicinity of 12.5. (Long term average is 14-14.5).

Average growth for earnings per share in FY10 (year closed yesterday) is a little above 4% while FY11 is expected to see a jump in the order of 19%.

Forecast dividend yields (for those companies who pay out a dividend in the ASX200) are 4.6% and 5.3% respectively.

Another conclusion drawn by the two Citi analysts: the biggest risk to next year's earnings forecasts seems to be concentrated in the mining sector. This is because both believe some of today's price assumptions for commodities do not match with their own top-down calculations.

Market strategists at Goldman Sachs Australia (ok, they're still called GSJBW) saw their list of absolute buy convictions underperform the broader market in June. They are quick in adding that since inception of their so-called Conviction List, now four years ago, their selection of stocks has outperformed in 71% of the cases and total outperformance is nearly 33% over the period.

The latest update sees the additions of PanAust ((PNA)), Equinox ((EQN)) and Mount Gibson ((MGX)) and the removal of Seek ((SEK)) and Intoll ((ITO)). Clearly, the strategists are taking the view that some resources stocks are poised for a bounce.

The freshly updated list of “Buy-rated stocks with conviction” now includes Aquarius Platinum ((AQP)), Asciano ((AIO)), Bradken ((BKN)), Equinox, Mount Gibson, News Corp ((NWS)), Pacific Brands ((PBG)), PanAust, Ten Network ((TEN)) and Wesfarmers ((WES)).

The small caps team at Credit Suisse has once again grabbed the opportunity to highlight how much they like Campbell Brothers ((CPB)). They have drifted away from market consensus by increasing profit estimates, while suggesting there's more positive news around the corner.

Small caps specialists at JP Morgan recently recited their absolute favourites: Blackmores ((BKL)), Credit Corp ((CCP)), Miclyn Express ((MIO)), Norfolk ((NFK)), Retail Food Group ((RFG)), Salmat ((SLM)) and Wotif.com ((WTF).

If my observation is correct, it has been a while since that list of small cap favourites has seen any changes.

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