(Most) Small Miners No Longer Attractive, Citi Concludes

This story features SOUTHERN CROSS MEDIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SXL

– small cap analysts at Citi have concluded most small miners are now fully valued

– Citi analysts still see value, but in selected small mining stocks only

– they suggest investors should shift attention towards small industrials

– Citi still likes gold miners, projecting strong gains in the year ahead

– plus market strategists elsewhere have made various changes

By Rudi Filapek-Vandyck

Fully valued, with some pockets of value left. Such was the conclusion when small cap specialists at Citi updated their sector views on Monday. No wonder thus, the analysts recommend investors should switch their focus to small cap industrial stocks instead.

To add some support to their thesis, the analysts stated bottom up valuations imply a total return for the Small Ordinaries of 9.8% in the year ahead. Note "total return" is the sum of prospective dividends plus anticipated share price appreciation. Citi analysts believe market beating returns should come from Consumer Discretionary (with a projected total return of 23.5%) and Consumer Staples (19.4%). Those investors who want to stay loyal to the Resources theme should be best off (on Citi's projections) with smaller gold stocks which carry a projected total investment return of 29%.

The analysts have lined up four preferred candidates to play the small industrials theme, these are Pacific Brands ((PBG)), Southern Cross Media ((SXL)), Alesco ((ALS)) and GWA International ((GWA)). We couldn't help but noticing there are quite a few small cap specialists in the market that has shifted preference to GWA recently. Some have been advocating switching out of GUD Holdings ((GUD)) in order to become a shareholder in GWA.

FNArena's website reveals Pacific Brands shares are trading some 9.5% below consensus price targets, with implied Price-Earnings rations (on consensus forecasts) placing the shares on multiples of 8.7x for FY11 and 7.9x for FY12. Add implied dividend yields of 5.7% and 7.2% respectively and it is easy to see why Citi likes the potential upside for this stock.

Shares in Southern Cross Media are trading more than 25% below consensus price targets with implied dividend yields of 6.8% and 7.4%. This is in line with what the R-Factor has been indicating since last year: the market is neglecting traditional media stocks in Australia. Neglect always leads to underpricing. Note: investors should always keep in mind that "valuation" is a lousy gauge for "timing".

Alesco shares are trading more than 10% below consensus target, with consensus forecasts anticipating its dividend yield will jump from 2.8% this year to 5.2% next.

GWA shares are the only ones trading on mid-teens multiples, with this year's prospective (consensus) PE ratio above 15x and next year's below 14x. No wonder, consensus target suggests there's only 3-4% upside left. While the implied dividend yield is still a healthy 5%+, it would nevertheless seem Citi's expectations are not widely shared. Or maybe they are, but they've already been priced in?

Mind you, consensus forecasts assume a jump in earnings per share in the order of 35% for GWA this year, to be followed up by 13.8% growth in FY12. This might imply that as market confidence increases in these numbers, the share price could potentially still rise further.

Buying the shares here would nevertheless be in breach of the strict valuation rules put forward by Warren Buffett and his side-kick Charlie Munger who long time ago decided any stock on a PE multiple above 15 is not worth their time or attention.

Citi's small cap analysts also put forward their favourites among small cap resources stocks: Medusa Mining ((MML)), OceanaGold ((OGC)), Resource Generation ((RES)), Gindalbie Metals ((GBG)) and Grange Resources ((GRR)). In simplistic terms, this becomes gold, gold, coal and uranium, iron ore and iron ore.

Citi also has picked three stocks it suggests should be sold/avoided/shorted at present share price levels. Among industrials the least liked candidate is Nufarm ((NUF)) while on the resources side the stockbroker picked Lynas ((LYC)) and Eastern Star Gas ((ESG)).

Most strategists and sector analysts have been rather quiet these past weeks. No wonder as we are currently in the midst of corporate reporting season. No doubt we will see more updates once the dust has settled in March.

Last update by market strategists at RBS, for example, was provided two weeks ago and contained quite a few shifts in preferences. At the time, RBS switched Myer ((MYR)) for Harvey Norman ((HVN)), Toll (TOL)) for Qantas ((QAN)) and Downer EDI ((DOW)) for Bradken ((BKN)). RBS strategists also believed it was time to add QBE ((QBE)) and Lend Lease ((LLC)) to their Model Portfolio. On the broker's short list at the time were Leighton Holdings ((LEI)), Aquila Resources ((AQA)) and Tatts Group ((TTS)).

RBS also reduced its ownership in WorleyParsons ((WOR)).

Macquarie strategists last updated their so-called Marquee Ideas for the year ahead on the same day as the RBS update, leading to four Outperform-with-Conviction nominations, offset by two Underperform-with-Conviction calls. On the negative side, Macquarie put the Australian Stock Exchange ((ASX)) and National Australia Bank ((NAB)). On the positive side, Macquarie nominated propery trust CFS Retail ((CFX)), Crown Media ((CWN)), Rio Tinto ((RIO)) and ResMed ((RMD)).

Note that on my observation, Macquarie's nomination of NAB on the sell-side is contrary to what happened elsewhere in February with most stockbrokers downgrading ANZ Bank ((ANZ)) on their list of sector preferences in favour of NAB and Westpac ((WBC)).
But that's not how market strategists at RBS see this year's scenario play out for the bank. On Wednesday, RBS strategists repeated their preference for ANZ Bank in the sector, alongside NAB. Also, RBS strategists believe this year might see a re-rating for the banking sector overall, which means higher multiples and this should translate into total returns of up to 20% (including dividends) by December. Such a view is definitely not widely accepted in the market and it is not reflected in consensus price targets either.

RBS strategists also added go long BlueScope ((BSL))/short Mineral Resources ((MIN)) to their sector calls with Conviction on Wednesday. Note Mineral Resources shares are currently trading well above consensus price target, while BlueScope is nowhere near.

Another sector idea put forward is going long Austar ((AUN))/short Ten Network ((TEN)). Would ongoing speculation about Foxtel ((CMJ)) having another go at Austar have something to do with this?

Finally, market strategists at Goldman Sachs did the inevitable on Wednesday morning, removing SEEK ((SEK)) from their Conviction Buy list after the company disappointed friend and foe with its interim report. The stockbroker still rates the stock as Buy, but there's no longer any conviction that whoever owns the stock will outperform the broader market on a six to twelve months outlook. Goldman Sachs still has no Sells-with-Conviction. The remaining names on its Buy-with-Conviction list are Aquarius Platinum ((AQP)), BHP Billiton ((BHP)), CFS Retail Property Trust ((CFX)), News Corp ((NWS)), PanAust ((PNA)), UGL ((UGL)) and Wesfarmers ((WES)).

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