Analysts Reconsider Resource Stocks

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

– Resource sector stocks have been hit by global risk aversion
– The fundamental picture is nevertheless little changed
– Rewards to be had for the sensible buyer

By Greg Peel

“While market moves in the past few days have been sharp, it is easy to lose perspective,” warns Credit Suisse. “The fact is, at an aggregate level things are not nearly as bad as they might seem”.

Goldman Sachs concurs. The recent jump in risk aversion has impacted negatively on commodity prices (gold is a currency not a commodity) but the Goldman analysts believe the medium-term fundamentals are little changed. Irrespective of renewed developed economy recession fears, China will continue with its social housing program and thus deliver growth in demand for raw materials, they suggest. It will be a slower rate of growth than in recent years nevertheless.

Supply-constrained commodities will continue to remain supply-constrained, says Goldman, thus limiting price downside. These include copper, iron ore, coking coal, mineral sands and rare earth metals.

RBS Australia points out that as the market has been weakening over the past few weeks, the spot iron ore price has actually risen slightly. Copper is still above US$4/lb. The big devaluation in the Australian resource sector over the past month looks well overdone against attractive valuations and healthy commodity prices, RBS suggests. 

Credit Suisse has become particularly favourably disposed to nickel of late. The global nickel index is slightly below trend, the analysts note, nickel stock valuations are below trend compared to nickel prices, and risk appetite for nickel appears to have contracted more sharply than it has for other metals. On that basis, CS has set Outperform ratings for Panoramic ((PAN)) and Mirabela ((MBN)).

Last week Goldman Sachs revised down its year-end forecast for the ASX 200 given the downturn in global sentiment, to 4450 from 5125. Included in that downgrade is a reduction in valuation and hence target prices for resource sector stocks. Ongoing volatility will have a greater impact on smaller and riskier stocks, Goldmans warns.

The impact is not overwhelming, with price targets falling by single digit percentages across the sector with the exception of uranium miners. Goldmans has sliced 11% off its Paladin Energy ((PDN)) target and 16% off its Energy Resources of Australia ((ERA)) target and has a Sell recommendation on both. The analysts retain Buy recommendations on BHP Billiton ((BHP)), Rio Tinto ((RIO)) and Fortescue ((FMG)) in the iron ore space, and Holds on Atlas ((AGO)), Mount Gibson ((MGX)) and Murchison ((MMX)). In the coal space they have Buys on Bathurst ((BTU)) and Macarthur ((MCC)) and Holds on Aston ((AZT)) and Whitehaven ((WHC)).

As short term trades in the current volatile environment, Goldmans likes BHP and Iluka ((ILU)). The analysts also take a “very favourable view of gold exposure” and thus recommend Newcrest ((NCM)).

RBS believes those with a longer term view will be rewarded by “cherry picking” quality miners at depressed price levels. A fundamental sector re-rating is not likely until the global macro backdrop improves, warns RBS, but cashflow generation remains strong so once sentiment improves, the miners could re-rate sharply, the analysts suggest.

RBS has upgraded Mt Gibson, Iluka and Paladin to Buy and moved Aquila ((AQA)) to Hold from Sell. The analysts' top three sector picks are Fortescue, Rio and Iluka, with runners-up Alumina ((AWC)), OZ Minerals ((OZL)), Atlas and Independence Group ((IGO)).

It became apparent after 2008, notes Macquarie, that sensible resource sector buying in weak and volatile markets can yield very large returns. In selecting their preferred plays the analysts have focused not just on the usual – low valuation and M&A appeal – but also on low-cost operators which are best placed in an environment of weaker commodity prices. In Australia, the analysts have settled on Rio (probably not for M&A appeal), Mount Gibson and Atlas.

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