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Analyst report
Mining sector will continue to boom, analysts say
February 27, 2008
Brendon Lau, ShareAnalysis
Over the last few weeks, base metals have disconnected themselves from bearish equities sentiment. We believe metals are a better barometer of the health of the real economies in the region that are directly tied to Australia's economic well-being.
The threat of a US recession and the global credit crisis has created panic amongst investors who have indiscriminately sold down most sectors. However, some investors in the mining sector have taken a contrarian view to the "sky-is-falling" scenario. As we have said a number of times, we believe these investors will come out of this financial storm smiling.
While the US economy might be teetering on the brink of a recession and Europe slows dramatically, there have been few signs of stress in the economies of emerging countries such as China and India, which are instrumental in Australia's economic well-being.
Adding to the bullish sentiment is the belief that China's growth would be largely unaffected by a US recession as previous sharp export slowdowns to the US (such as the recession in the late 80s and the downturn following the "tech bust" and 9/11 attack) had minimal impact on the country's GDP growth. The export slowdowns over these periods were well cushioned by domestic investment and consumption.
We expect the downturn in the US to knock 1% to 2% off China's GDP, but the Chinese economy should still continue to grow at a healthy pace of between 8% and 9% per annum for the medium term. However, we would not go so far as to say the rest of the world has decoupled from the US, instead the US and the rest of the world have de-synchronised, with the US economy not having the effect it once had.
The run-up in industrial metals amidst the global equities rout is not just demand-side driven. Worries of a supply crunch due to the shortage of equipment and manpower, labour unrest, bad weather, copper production shortfalls in Chile and a severe power outage in South Africa have also been supporting prices. These reasons, combined with the relatively low inventory levels of most industrial metals, are why we believe metals prices will stay above historical trends for the medium term, at least.
Our positive view is further reinforced by the high levels of interest in merger activity worldwide in the sector - and miners are arguably in the best position to gauge future metals demand. This means that any sustained share price weakness amongst resource stocks could trigger more M&A activity in the wake of BHP Billiton's (BHP) audacious bid for Rio Tinto (RIO).
On the downside, one of the biggest challenges facing the industry is rising costs. However, investors will be pleased to know that while this headwind is hurting the bottom lines of miners, there is a silver lining. We believe that rising costs are likely to help keep commodity prices at lofty levels as a function of basic economics - commodity prices will have to, at least, keep pace with the costs of bringing new projects on line, and without these new projects aimed at easing the supply crunch, metals prices are unlikely to fall much.
Out of the few miners we have a BUY on, the following two stand out:
BHP Billiton's (BHP) EBITDA margin has declined by 3.8% on the pcp to 43.7%. Higher production volumes and commodity prices were offset by rising costs. However, BHP is in a better position to weather this margin contraction than many of its smaller peers. We have adjusted our cost assumptions moving forward, resulting in a 5% drop in our 2008 EPS forecasts. The stock remains in our Balanced and Growth portfolios and we maintain our BUY on BHP with a 12-month price target of $45.63 (Technical Recommendation: BUY).
Minara Resources' (MRE) management appears to be extremely confident that MRE's newly refurbished HPAL plant will continue to meet expectations. MRE suggested that the plant should now produce 35kt of nickel pa (up 11% on previous record) on a 97% utilisation rate. However, the company is still suffering from rampant cost inflation. We have a BUY on MRE with a 12-month price target of $6.59 (Technical Recommendation: BUY).
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
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Resident Trader: Perils of trading when short-term market activity is often random
Advisor Lounge: Reducing tax on investment properties with DIY super
Sectors: Mining sector will continue to boom, analysts say
Commodities: Gold still shining brightly
Expert Panel: Receiving dividends with CFDs
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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