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 British-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 Herald does not take responsibility for stock recommendations. Readers should seek the advice of a licensed financial adviser.
Frequently Asked Questions about this Article…
What does the recent All Ordinaries Index rally mean for everyday investors?
Since June 4 the All Ordinaries has jumped almost 10%, which has lifted investor sentiment. The article warns this could be a false dawn but says investors should consider what assets give them the best leverage to a potentially renewed bull market — while also being mindful of the risk that the rally could fade.
Is Whitehaven Coal (WHC) a bargain while Nathan Tinkler’s $5.20 offer is unresolved?
Whitehaven was trading around $3.40 while Nathan Tinkler’s $5.20 bid was in play. If the $5.20 offer succeeds, buyers today could see about a 50% gain quickly. If the bid fails, the stock may initially fall as the market braces for a possible sell-down, but analysts still value Whitehaven around $5.50–$6.00 a share — roughly 60% above the then-current level — so a recovery is possible.
What are the risks to Whitehaven Coal if the takeover bid doesn’t go through?
The main short-term risk is an initial price fall as the market anticipates a potential sell-down by the bidder. Over the medium term, fundamentals could reassert themselves and the stock could rally to analyst valuations near $5.50–$6.00 a share, but short-term volatility is likely if the bid fails.
What should investors know about Fortescue Metals (FMG) and exposure to iron ore prices?
Andrew Forrest bought about $130 million of FMG stock at $4.85 but the share price slid to about $4.02. The company is sensitive to iron ore prices: the market had believed a floor around US$115–120/tonne, but prices recently fell to US$106/tonne. If iron ore stays below about US$100 for a sustained period it would be uncomfortable for Fortescue given its large expansion-related debt (peaking just under $10 billion) even though its cash cost of production is roughly US$70/tonne.
How could changes in Chinese steel production affect iron ore and mining stocks like FMG?
A sharp slump in Chinese steel production was the catalyst for the recent iron ore drop to US$106/tonne. If China ramps up stimulus and boosts activity, iron ore could bounce back above US$115/tonne, which would be very positive for miners like Fortescue. If China doesn’t step in, prices could fall further (the article notes a possible slide to around US$90/tonne), which would put pressure on miners’ profits and balance sheets.
Why might Henderson Group (HGG) be an overlooked opportunity for Australian investors?
Henderson is a British funds manager often overlooked by Australians focused on domestic names. The article notes Henderson reported earnings per share of about 10 (as reported), the stock jumped about 20% in the past month, and if the firm sees stronger fund inflows in a rising global market it could benefit from rising fees and an expanding P/E multiple. The piece gives an illustrative scenario where higher earnings and a higher multiple could meaningfully lift the share price (for example, moving from $1.66 to $3.60 under a specific set of assumptions).
What corporate responses could happen if iron ore prices remain weak?
The article suggests sustained iron ore prices below roughly US$100/tonne could weaken some producers and create consolidation opportunities. In that scenario, larger miners such as BHP and Rio Tinto might look to expand by acquisition, while higher-cost producers could be knocked out of the market, tightening future supply dynamics.
What general caution does the article offer everyday investors considering these opportunities?
The article highlights both opportunity and risk: takeover bids, commodity swings and earnings momentum can create big moves, but they also bring volatility and downside. It closes by reminding readers that the newspaper doesn’t take responsibility for stock recommendations and that investors should seek advice from a licensed financial adviser before acting.
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