The Materials (Mining) Sector

Continuing my sector review theme, I now turn my attention to the Materials sector that is an unusual mix of mining and building companies – but that is how the GICS (Global industrial Classification System) defines this one of 11 major sectors. Since there are 22 companies in the top 100, I am splitting the analysis into two parts: one for mining stocks and one for the others. That leaves 11 stocks in my ‘unofficial’ Materials (Mining) sector. For brevity, readers should refer to my last piece on the Energy sector and the previous piece that compares all 11 sectors for details.

The table contains much of the information I use in stock selection. These stocks account for 76.7% of the market capitalisation of the ASX 200 Materials sector – the sum of the column headed ‘Market cap. share’. The non-mining sectors accounts for 14.4% and the remaining 8.9% is the lower 100 of Materials stocks in the ASX 200.

Note: the estimates in the Table are current to the close of business 16th November 2012. They are based on Thomson Reuters Datastream. The price target is the brokers’ forecast of where the stock price is heading – often considered to be in the next 12 months.

The top three stocks (BHP, RIO and Newcrest) all have reasonable to very good ratings with a Consensus Recommendation (‘Consensus re.’) of 2.5 (market outperform) or less. I believe that many investors favour Newcrest because they see it as a ‘gold play’ without resorting to buying the commodity. However, the correlation between the gold price and NCMs price is not that high. Apparently, gold miners extract from more difficult, hence costly  locations when the price is high. I have a personal aversion to anything associated with gold!

Atlas and Lynas

I have held Atlas (AGO)(and Lynas (LYC) for some time to accompany my BHP and RIO holdings. When I first purchased AGO and LYC they were not in the top 100 but they had excellent ratings. I chose to use these stocks as my Small Cap exposure and have added to and sold during the time since my first purchases.

AGO, a Western Australian iron ore miner had looked promising until the middle of this year when the negative stories about China emerged in great numbers. The price fell sharply but the rating – at 2.1 – remains firm. Since I always believed that the China in slowdown story was well overdone, I have not sold recently since I am not fleet of foot enough to be a trader. I believe in the long run prospects.

LYC was the market darling of 2011. It mines rare earths that are used in many high tech products – and China produces about 95% of world output. The price rocketed up from under 20 cents to nearly $3. I sold nearly half of my exposure to lock in a guaranteed profit even if the price of my remaining holding falls to zero. Therefore, I felt it reasonable to hold on to the stock during the protests in Malaysia that have been trying to prevent LYC from processing there. There is the danger that the plant will not go ahead but the rare earths are still owned by LYC in Australia – but the share price would no doubt fall. Given the Malaysian government signed off on the plant and it has withstood a couple of appeals, there is scope for a potentially very valuable stock. Its current rating of 2.8 is not impressive and reflects the political nature of the stock.

Iluka, Ozminerals, Panaust, Perseus and Fortescue

The ratings for Iluika (ILU) and Ozminerals (OZL) are too poor for me to consider buying at present and Panaust (PNA) and Perseus Mining (PRU) are too dependent on exploration for my liking. Regis Resources (RRL) is dependent on gold mining and so is not one for me. Fortescue (FMG), the iron ore miner, went through some well publicised debt negotiations recently, but my reason for not holding it is because its fortunes seem to be too linked to the charisma (and ability!) of its chairman, Andrew Forrest. Too much key man risk for me.

BHP, Rio and Newcrest

Turning back to the big three stocks in the sector, the last 12 months data on their recommendations are shown in Figure 1.  All ratings have deteriorated – along with the controlled slow-down in China but NCM has taken a bigger jump recently – adding to my lack of interest in the stock. RIO looks to be preferred to BHP not only because of its current rating but the widening gap.

Note: the estimates in the Figure are current to the close of business 16th November 2012. They are based on Thomson Reuters Datastream. The price target is the brokers’ forecast of where the stock price is heading – often considered to be in the next 12 months.

We currently have the whole Materials sector predicted to have the best capital gain of the 11 sectors over the next 12 months of 27.5% and, from Figure 2, the sector is well underpriced (-6.8%). We did have the sector very overpriced in 2009 and sufficiently overpriced for a correction in late 2010.

With the consensus target price range of $31.74 to $52.67 with a median of $39.14, BHP stock price makes it worthy of consideration. For RIO the range is $60.49 to $104.84 with a median of $74.57 making it more attractive than BHP, which is consistent with the ratings differential. Clearly the risks associated with these forecasts – in particular – should be taken into account and the possibility that any of these data points/forecasts may change rapidly, and often do.

Note: the estimates in the Figure are current to the close of business 16th November 2012. They are based on Thomson Reuters Datastream. Please go to www.woodhall.com.au for more information on the assumptions behind the estimates.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.