Despite the falls in commodity prices and rises in operating costs, Andrew Doherty of Morningstar believes that resource companies have been oversold. And he names resource companies and the banks as the most undervalued businesses.
“On our numbers, resource stocks are as much as 27 per cent undervalued.”
And Doherty argues that although the pressure on costs and commodity prices will continue, resource companies provide opportunities for investors willing to accept their level of volatility.
Morningstar’s favoured resource stocks are BHP Billiton and Rio Tinto, given their diversified revenue sources – long-life, low-cost assets – and their healthy balance sheets.
Morningstar forecasts that BHP Billiton will pay a grossed-up dividend yield (which includes the value of franking credits) of 5.14% for 2011-12 while Rio Tinto is expected to pay a grossed-up dividend yield of 4.14%.
Dominic McCormick of Select Asset Management says the miners have been clearly oversold on concerns of reduced Chinese growth. “Although the boom in many commodity prices may be over, we still see a case for strong volumes. The developing market story is not dead.”
Certainly, the big diversified miners pay significantly lower dividends than, say, the banks: “But I don’t think people should get overly obsessed with yields,” says McCormick.
“And I think that despite the lower yields, there is likely to be more pressure on the boards of the better-placed miners to deliver value back to the shareholders. Dividends are likely to be higher.”
Prasad Patkar of Platypus Asset Management has some reservations about the large diversified miners. “Their boards have shown no desire to return surplus cash to shareholders – even when rivers of gold were breaking the banks. Now that commodity prices have flattened, their cost pressures are intense and capital commitments are high – they are feeling the squeeze.
“I’d much prefer to take exposure to the resources sector via smaller companies with proven management that can grow production and control costs,” Patkar adds.
David Cassidy of UBS says the big diversified miners appear to provide value at current share prices but underlines the risks to commodity prices if there is a downturn in Chinese growth or a further deterioration in global economies.
Cassidy believes that certain stocks that are linked to the mining boom provide more protection than BHP Billiton and Rio Tinto. And he points specifically to freight and port operator Asciano and mining services provider Orica. He says their businesses depend on volume, not so much on commodity prices.
Not surprisingly, the share specialists interviewed highlight other opportunities outside the banks, miners and supermarkets.
David Cassidy of UBS, for instance, points to Telstra. Its grossed-up dividend yield for 2011-12 will exceed 10% – despite the rise in its share price. “Telstra has a very defensive earnings stream,” he says.
However Cassidy adds that although Telstra is experiencing a “growth spurt at the moment”, its long-term prospects for growth are “not terribly exciting.”
Prasad Patkar of Platypus Asset Management believes that a number of small, growing companies provide returns that are typically uncorrelated with the overall sharemarket. This means if the overall market dips, the prices of such stocks may rise.
Such companies held by Platypus include Domino’s Pizza, Sirtex Medical, and engineering and infrastructure group Cardno.
