Resource stocks hold up despite October sell-off
The big Australian resources companies have had a strong run in the past year and not even October’s market correction has wiped away their gains.
The big Australian resources companies have had a strong run in the past year and not even October’s market correction has wiped away their gains.
Ongoing global growth could propel them higher, with BHP Billiton (ASX: BHP) a favourite among some analysts due to its diversified exposures to oil and iron ore.
While the S&P ASX 200 was down almost 6 per cent for the year to date at the time of publishing, BHP is up around 6 per cent, having benefited from stronger iron ore and oil prices. Oil and gas company Woodside Petroleum (ASX: WPL) is up around 3 per cent.
Higher oil and iron ore prices have been a big support for these companies, and improved momentum in US and global economic growth has also boosted their share prices.
“Strong economic growth globally has definitely helped, but so has China’s continued investment in fixed assets,” says Morningstar mining analyst Mathew Hodge.
For Woodside, the stronger run versus the overall market has been driven by a recovery in oil prices, from US$35 in early 2016 to US$80 recently.
“Energy prices will always be the most important driver for WPL but this won’t make it immune to a general market sell-off,” says Mark Taylor, Morningstar’s Woodside analyst.
In addition to the commodity price boom, investors are also likely rotating into resource stocks out of higher price-earnings (P/E) stocks. This are being hit by higher interest rates in the US, and have sold off especially hard during October.
“Rising interest rates in the US are dragging on high P/E stocks, but we haven’t really seen a material impact on global growth yet. So, we may be seeing a rotation out of interest rate sensitive stocks – real estate, infrastructure, high P/E growth stocks, into lower P/E stocks such as resources with investors willing to bet the next six to 12 months will still be ok,” says Hodge.
“I think as interest rates continue to increase, then eventually that will weigh on growth and you’ll see an impact on commodities. Also, further moves in China to address growing debt should slow commodities consumption over time.”
Hodge places a fair value estimate on BHP of $25.00, below its current market price of $31.57. His fair value estimate for Rio Tinto (ASX: RIO) is $52.00, below its market price of $74.76.
“We think BHP is less expensive given a smaller exposure to iron ore, and the addition of oil to the portfolio where we are relatively more optimistic on the outlook,” says Hodge.
BHP's share price is lower due to its smaller iron ore exposure, says Morningstar's Hodge
Adrian Prendergast, resource analyst with Morgans, has an ‘add’ recommendation on BHP Billiton, which has a mix of commodities exposures to iron ore, coal and oil. As a result, “we see a potentially significant period of exceptional cash flow generation (save for any global financial crisis).”
Prendergast recently updated his BHP Billiton price target to $40.02, saying it is his pick of the miners. “Sustained capital discipline combined with healthy demand fundamentals have delivered a potentially extended upcycle in resources, with BHP still our top pick,” says Prendergast.
He adds that how and when BHP will distribute its near-US$11 billion of net proceeds from the sale of its US onshore oil and gas assets will be decided at a board meeting in late October, though shareholders could benefit from the cash flow.
“It remains our view that the proceeds will be split between a special dividend to reward income-focused retail investors, and a buyback. In addition to the asset sale proceeds, we expect capital management will remain a focus for BHP in future results given its free cash flow outlook,” Prendergast says.
Prendergast also has an ‘add’ recommendation for Rio Tinto, and recently increased his Rio price target to $82.28 from $81.32 and maintains. “The key risk to our call remains commodity price risk,” he says.
Unlike the two big miners, Prendergast has a ‘hold’ recommendation on Woodside Petroleum, with a target price of $36.74. He says much of the good news on its gas projects is priced into the stock.
In contrast, Morningstar's Woodside analyst Mike Taylor has a higher fair value estimate of $46.50 on Woodside and holds a positive outlook on the stock. Taylor has based this estimate on a Brent crude oil price of US$82 per barrel and an exchange rate of US$0.71, though over the longer term, he has a US$60 forecast.
“Under its watch, the number of LNG trains has grown from one to five taking gross output to 16.4 million metric tons per year. This pedigree is unmatched in the Australian oil and gas space and there's more potential development in the pipeline if prices will allow,” says Taylor.
“Missteps, including commissioning delays and cost blowouts during the China-driven resources boom, are now past. Woodside has demonstrated commendable conservatism in capital allocation over several years.”
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Nicki Bourlioufas is a contributor for Morningstar Australia.
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