These 5 stocks led large-cap share price growth in 2016
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Resources companies dominated the top tier of companies covered by Morningstar Australasia in 2016, in terms of share price growth measured over calendar 2016.
The top four are mining businesses, with the fifth a global steelmaker.
According to Peter Warnes, Morningstar's head of equities research, resources "reversed all the losses [to become] the best-performing sector of the market in 2016".
He attributes much of this outperformance to higher-than-anticipated Chinese demand, which "had a profound impact on commodity prices, a positive for Australia's mining companies and trade".
"The strength in commodity prices--particularly iron ore and metallurgical coal--surprised, aided by disruptions to supply with the Samarco disaster in Brazil and weather-related issues affecting production of coal and iron ore in Queensland and Western Australia," Warnes says.
At the top of this list for 2016 is Whitehaven Coal (ASX: WHC), which recorded share price growth of 270 per cent over the calendar year.
Morningstar's fair value estimate (FVE) for Whitehaven was increased almost two-fold in December, to $1 from 55 cents per share, in line with higher coal prices--which quadrupled in 2016--along with ongoing demand strength and other factors.
"The large change reflects all revenue being exposed to coal, the material near-term uplift in prices and high operating and financial leverage," says Mathew Hodge, Morningstar's sector lead-basic materials, energy and utilities.
However, he also emphasises the stock has a "very high fair value uncertainty rating" and "our no-moat rating reflects the lack of cost advantage and forecast midcycle returns well below the cost of capital," anticipating a China-driven decline in the recent coal price rally.
The world's fourth-largest iron ore exporter, Fortescue Metals Group (ASX: FMG), occupied second place in terms of share price growth over calendar 2016, up 230 per cent for the year.
Its FVE was increased to $2.80 in December, from $1.70, with the higher near-term iron ore prices and commodity demand that "exceeded expectations in 2016 thanks to China's debt-fuelled stimulus," Hodge says.
"Fortescue has grown rapidly thanks to incredibly favourable iron ore prices, aggressive management and historically low interest rates on high-yield corporate bonds," he says, but tempers this by pointing to the company's much higher leverage relative to its peers.
"The company is not well positioned for the low-price environment we expect to persist, and its fortunes hinge on the expansionary whims of low-cost players with better balance sheets, such as BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO)."
Iron ore producer and mining services company Mineral Resources (ASX: MIN) took third-place in 2016, with share price growth of 217 per cent in 2016.
The Perth-based company listed on the Australian Securities Exchange in 2006 and caught the peak of the iron ore boom.
Its FVE was also increased in December, to $6 per share, from $4.10. Regarded as a high-cost producer, its iron ore operations lack some of the scale-driven cost advantages of its competitors, with no integrated rail or port infrastructure.
"Our fair value estimate hinges on the mining services division, which accounts for all of Mineral Resources' profits from fiscal 2019," says Hodge.
"Relatively high costs mean the company has significant operating leverage to the improved iron ore prices ... [which we expect] to be meaningfully cash-generative until fiscal 2019 before becoming moderately loss-making."
Mineral Resources' crushing and screening business--its mining services division--is expected to offset some of this slack from 2019. According to Hodge, this operation is superior to the iron ore business because Mineral Resources owns fixed plant and equipment at customers' mines, which is important in the production of iron ore.
However, he also sees potential margin pressures ahead, with mining companies possibly using the sector slow-down as leverage to drive down the prices they pay contractors.
In fourth position, with share price growth of 160 per cent in calendar 2016, is BHP spin-off South32 (ASX: S32). Its multinational operations span the mining and production of bauxite, aluminium, coal, manganese, nickel, silver, lead and zinc in Australia, Southern Africa and South America.
A modest FVE increase was made last month, to $1.70 from $1.50, on the back of higher prices for coal and manganese.
However, the stock's high fair value uncertainty persists due to the cyclical nature of commodity prices. "We don't believe the recent rally in coal prices is sustainable ... and South32 remains significantly overvalued," says Hodge.
Its highest-quality operations are Australian manganese and Cannington silver, lead and zinc, both in the lowest-cost quartile and which have historically generated excess returns on invested capital.
Despite its manganese business returning more than 20 per cent for the five years ended fiscal 2014, Hodge doesn't expect those returns to recur, given the peaking of China's steel demand.
"As they have been for iron ore and coking coal, we expect prices and returns for manganese to be much softer in future," he says.
Another BHP spin-off, global steelmaker Bluescope Steel (ASX: BSL), rounds out the top five, with share price growth of 112 per cent in 2016.
It also saw a modest FVE increase, to $3.90 from $3.50 at the end of 2016, largely due to US president-elect Donald Trump's stated aim of large-scale infrastructure investment using American steel. Bluescope is expected to benefit through its fully-owned North Star electric arc furnace in Ohio.
Accordingly, Hodge points to a 21 per cent adjustment in Morningstar's fiscal 2017 earnings forecast, to 75 cents per share versus 47 cents per share in fiscal 2016.
Despite the company's better-than-expected performance in the second half of calendar 2016, he says: "We think earnings are near a cyclical high and BlueScope is significantly overvalued."
Hodge anticipates returns on adjusted capital to rise to 9.3 per cent in fiscal 2017, up from 6.9 per cent in the same period 2016. "However, we forecast only mid-single-digit returns in fiscal 2021, reflecting the lack of cost advantage and our no-moat rating."
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Glenn Freeman is Morningstar's senior editor.
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