INVESTORS need to start thinking about what gives them the best leverage to a firing equity market. Since June 4, the All Ordinaries Index has jumped almost 10 per cent and there is a noticeable spring in the step of professional investors. This may be another false dawn for stocks, but investors would be negligent ignoring the possibility of a fresh bull surge.
Whitehaven Coal (WHC)
IT HAS been difficult to make an investment call on the thermal and coking coal play, given the negative news surrounding the $5.20-a-share offer for the company by Nathan Tinkler. The stock is trading at just $3.40, with the market signalling the entrepreneur will fail to come up with the funding. But with the bid process coming to a close, a rare opportunity may be emerging for investors.
If the $5.20 offer succeeds, those buying the stock today will make about 50 per cent quickly. But if the bid fails, the fundamentals will come into play. Under this scenario the stock would initially fall as the market braced itself for a sell-down by Tinkler. Once this concern was dealt with the stock could rally strongly, with analysts valuing Whitehaven between $5.50 and $6 a share, or about 60 per cent above the current level.
Fortescue Metals (FMG)
ANDREW Forrest waded into the market in June and bought about $130 million of stock at $4.85 a share. Since then the iron ore producer has gone on a wild ride, with the stock now wallowing at $4.02. Forrest will not be overly concerned about the short-term machinations of the share price.
Of more concern is the price of iron ore. For some time iron ore producers and analysts believed the bulk commodity's price had a fairly sturdy floor under it of $US115 to $US120 a tonne. Effectively this represented the cost base for many of the Chinese producers. In simple terms it was believed a price below $US115 a tonne would knock out many of these producers, dramatically reducing supply.
In recent days the price has sunk to $US106 a tonne. The catalyst for the decline has been a dramatic slump in steel production in China. This could be a short-term bottom and the price may jump back above US$115, especially if China decides to increase its stimulus spending and ignites activity.
But if the Chinese government does not come to the rescue the fear is iron ore prices could slump to $US90 a tonne. This would be highly uncomfortable for Fortescue. Even though its cost of production is about $US70 a tonne, the company is in the midst of a big expansion program. This will see debt peak at just under $10 billion in the next 24 months. A consistent price under $US100 during this period would make it difficult for Fortescue to pay off its debt under the current arrangements.
A jump in price would see the stock rocket, while a fall below $US100 would see the share price leg down. If the latter happens, the big boys BHP and Rio Tinto - might expand by acquisition.
Henderson Group (HGG)
THE UK-based funds management group is normally overlooked by investors in Australia who concentrate on local players AMP and Perpetual. This lack of interest may just create an opportunity for investors. Henderson last week reported earnings a share of about 10?. The result was slightly down on the previous half-year, but this has not unnerved investors, with the stock jumping 20 per cent in the past month. If the company can double its half-year result and earn 20? a share for the 12 months to December 2012, it is trading on a P/E of eight times. Historically the stock has traded on a P/E ratio of 11 or 12 times.
In a scenario of a sustained appreciation in global equities, the company could see fund inflows resulting in rising fees and profits. This effectively provides the double whammy of rising earnings due to buoyant markets, together with an expanding PE multiple.
If, for example, the company could lift earnings 50 per cent to 30? a share and trade on a multiple of 12 times then the share price would move from $1.66 to $3.60.
matthewjkidman@gmail.com
The Age does not take responsibility for stock recommendations. Readers should seek the advice of a licensed financial adviser.
Frequently Asked Questions about this Article…
The All Ordinaries has jumped nearly 10% — how should everyday investors think about taking advantage of a firing equity market?
The article suggests investors should think about what gives them the best leverage to a rising market. Since the All Ordinaries rose almost 10% from June 4, consider selectively positioning in stocks that could benefit from a sustained rally — for example, companies mentioned in the piece like Whitehaven Coal, Fortescue Metals and Henderson Group — while being mindful of the company-specific risks and catalysts that could drive big moves.
What's the investment opportunity and risk around Whitehaven Coal (WHC) right now?
Whitehaven is trading around $3.40 while Nathan Tinkler has a $5.20-a-share offer on the table. If the $5.20 offer succeeds, buyers today could see roughly 50% upside quickly. If the bid fails, the stock may fall initially as the market absorbs a potential sell-down by the bidder, but the company’s fundamentals could then drive a strong rally — analysts cited valuations between $5.50 and $6.00 a share (about 60% above the current level).
How does Nathan Tinkler’s $5.20 offer affect Whitehaven shareholders and potential buyers?
Tinkler’s $5.20 offer is the key catalyst. The market is pricing in the possibility he may not secure funding, which is why Whitehaven trades well below the offer. If he completes the bid, shareholders and new buyers would likely benefit from a quick rise to that offer level. If the bid fails, expect short-term pressure followed by a potential rebound if fundamentals remain sound.
What are the main risks for Fortescue Metals (FMG) investors according to the article?
The biggest risk is the iron ore price. The article notes iron ore recently fell to about US$106/tonne from an assumed floor of US$115–120, driven by a slump in Chinese steel production. If prices stay under US$100 during Fortescue’s expansion (its debt is expected to peak just under $10 billion), it could be hard for the company to manage debt under current arrangements. A drop toward US$90/tonne would be especially uncomfortable; conversely, a jump back above US$115 would likely send the stock higher.
Why does the article mention Andrew Forrest buying Fortescue shares and what does that mean for investors?
Andrew Forrest reportedly bought about $130 million of Fortescue stock at $4.85 a share in June, showing insider confidence. The article points out he’s unlikely to be worried by short-term share price moves, but the real driver for Fortescue is iron ore prices and the company’s large expansion and debt profile — so investors should weigh commodity risk rather than short-term insider buying alone.
Is Henderson Group (HGG) a potential value play for everyday investors?
Henderson, a UK funds manager often overlooked by Australian investors, reported earnings per share slightly down on the previous half and its stock has jumped about 20% in the past month. The article lays out a scenario where if Henderson can double its half-year result and lift full-year earnings (the piece uses analyst scenarios), its P/E could expand from current levels toward historical norms, potentially moving the share price from around $1.66 to about $3.60. This makes it a candidate for investors who believe in a sustained global equity upswing and resulting fund inflows.
How would a sustained global equity rally affect fund managers like Henderson Group?
A sustained appreciation in global equities could bring fund inflows, raising management fees and profits for firms like Henderson. That would boost earnings and could expand the company’s P/E multiple — a double effect that, according to the article’s examples, could meaningfully lift the share price if markets remain buoyant.
Should I act on the stock ideas in this article or seek professional advice?
The article notes it does not take responsibility for stock recommendations and explicitly advises readers to seek the advice of a licensed financial adviser. Use the company-specific information and catalysts discussed (offers, commodity prices, earnings scenarios and debt levels) as starting points, but get personalised advice before making investment decisions.
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