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3 Aussie stocks with strong China ties

Lex Hall  |  25 Sep 2018Text size  Decrease  Increase  |  
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This trio of commodities companies hold strong intersections with Chinese demand, which brings both opportunities and risks.

China’s appetite for high-grade commodities is becoming insatiable as it seeks to curb pollution, says Dermot Ryan, a co-portfolio manager of AMP's Australian equities team.

Despite the escalating trade tensions with the US, he believes China’s pledge to stem toxic levels of air, water and soil pollution will boost its demand for high-grade commodities.

“China’s energy demand continues to grow, yet the focus on reducing pollution through President Xi Jinping’s ‘beautiful China’ policy is seeing its fuel imports switch from coal to LNG.

“This policy is also seeing its vast steel industry switch to high-calorific coal and iron ore, which drive operating efficiencies and are less toxic to the environment. Meanwhile the desire to be central to the electric car revolution is driving demand for those commodities required in developing battery technology," Ryan says.

China Xi-Jinping

Chinese leader Xi Jinping has vowed to curb the country's severe pollution

AMP's Ryan believes Australian miners that are "well-exposed to changing demand for commodities" have strong opportunities over the next few years.

"However, those dependent on ‘dirty commodities’ such as low-calorific coal or bauxite face more challenging times," he says.

Local oil major

Oil and gas producer Woodside Petroleum (ASX: WPL) is well placed to seize on Chinese demand for LNG, according to Morningstar, which recently boosted its share price outlook.

“China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing towards oil parity on an energy-equivalent basis,” says Morningstar senior equity analyst Mark Taylor.

Morningstar increased its share price outlook for Woodside following its reported US$566 million in profits for the half-year ended 30 June, up 12 per cent on last year and 6 per cent higher than the previous half.

However, the decision to boost the fair value estimate of Australia's biggest oil and gas player is based on currency movements rather than a change in long-term operating assumptions or oil and gas prices, according to Taylor.

The result was "about 4 per cent shy of our forecast, however, the small miss reflects chiefly a higher-than-anticipated effective corporate tax rate of 32 per cent, due to timing issues," Taylor says.

Shares in Woodside were trading at $37.16 at 2.25pm yesterday, a 24 per cent discount to Morningstar's $46.50 FVE.

Rio remains over-valued

Anglo-Australian miner Rio Tinto (ASX: RIO) is a direct beneficiary of China’s increasing appetite for natural resources, but there are caveats, says Morningstar equity analyst Mathew Hodge.

Rio Tinto last week announced plans to buy back Australia-listed shares before the end of the year as part of moves to return to shareholders about $4.41 billion in proceeds from the sale of coal assets.

The buyback will target the purchase of up to 41.2 million shares through an off-market program worth about $2.7bn, as well as further on-market purchases of shares.

The sales comes after Rio Tinto last month reported a 33 per cent jump in first-half net profit to $US4.38 billion ($5.9 billion), driven by a recovery in commodity prices.

Rio's underlying earnings - which excludes impairments and exchange losses - rose 12 per cent to $US4.416 billion from $US3.9 billion a year earlier.

Earlier this year, the PwC Mine 2018 report suggested many top miners had fallen into the trap of overpaying for mineral-producing assets during the China boom to meet rising demand.

“Rio Tinto's investment track record through the boom was woeful,” says Hodge. “The company paid too much for acquisitions and expanded when it was expensive, permanently diluting returns.”

Like its peer BHP Billiton, Rio Tinto has ridden the commodity supercycle since the early 2000s. Rio Tinto's asset portfolio is less diversified, with iron ore generating most of its value.

Rio Tinto is trading at $78.77, well above its fair value estimate of $48.00.

The big Australian

In its annual report last week, BHP Billiton (ASX: BHP) said it feared trade tensions could hurt investment and sentiment in China – the miner’s biggest customer, which accounts for about half of its sales.BHP, however, is upbeat, saying it expects living standards to rise and that urbanisation, industrialisation and trade would support demand.

"China still offers rich opportunities due to its large scale, ongoing urbanisation and the Belt and Road Initiative, despite its ongoing structural shift away from manufacturing towards services," it said.

Hodge is more bearish on the outlook, noting that overinvestment during the China boom, when capital costs were very high relative to historical standards, has diluted expected future returns.

“The global economy is cooling and demand for commodities will follow suit,” Hodge says.
“The China boom will never recur, and commodities are at the beginning of a long, slow secular decline.”

BHP last month posted a record dividend this year despite a 37 per cent loss in profit.
It reported US$3.7 billion full-year year net profits, down 37 per cent on 2017, due to US$5.2 billion of impairments and charges.

However, management also announced a record dividend of 63 US cents a share fully-franked, 20 US cents up on fiscal 2017's previous record of 84 cents.
BHP's share price was trading at $33.89 at 3pm Sydney time, a more than 30 per cent premium to Morningstar's most recent $24.50 fair value estimate.

 

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Lex Hall is a Morningstar content editor, based in Sydney.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is content editor for Morningstar Australia

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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