Docstoc

IML's position on Industrial and Resource stocks

Document Sample
IML's position on Industrial and Resource stocks Powered By Docstoc
					IML’spositiononIndustrial
andResourcestocks
August2008



 E
“ nergyandminingcompanieshavehadastellarrunforthepastfiveyears,
 butwilltheykeepitup?Webelieveonehastobeverycarefulextrapolating
 thisintothefutureandthathigh-qualityindustrialcompanieswilldeliver
 consistentreturnsoverthelongerterm.”

                                                              1000
                                                                   Nominal $
Industrial stocks favoured for the long-term                  1000
                                                                   Nominal $
                                                               800
InvestorsMutual’sinvestmentphilosophyisbasedonthe
                                                               800
premisethatindustrialcompanies,byvirtueoftheirvery
                                                              600
nature,willoutperformresource(energyandmining)
                                                              600
companiesovertime.Manyindustrialcompanieshave
                                                              400
recurring,predictableearningsbasesandtendtobe
                                                              400
‘pricemakers’.Theyproducedifferentiatedproducts,
                                                              200
whichtendstounderpintheirearningsbase.Formany
                                                              200
industrialcompanies,thisearningsbasetendsto
                                                                 0
producereliablefreecashflows.Thiscanbedistributed
                                                                     1957
                                                                     1960
                                                                     1963
                                                                     1966
                                                                     1969
                                                                     1972
                                                                     1975
                                                                     1978
                                                                     1981
                                                                     1984
                                                                     1987
                                                                     1990
                                                                     1993
                                                                     1996
                                                                     1999
                                                                     2002
                                                                     2005
                                                                     2008
                                                                 0
                                                                        1957
                                                                        1960
                                                                        1963
                                                                        1966
                                                                        1969
                                                                        1972
                                                                        1975
                                                                        1978
                                                                        1981
                                                                        1984
                                                                        1987
                                                                        1990
                                                                        1993
                                                                        1996
                                                                        1999
                                                                        2002
                                                                        2005
                                                                        2008
throughdividendsorreinvestedtogrowtheearningsof
thecompanyovertime.

Commodity prices                                                10
                                                                   Real $
                                                                10
Incontrast,resourcecompaniesaretypicallyexposed             Real $
                                                                 8
tothevolatilityandunpredictabilityofcommodityprice
                                                                 8
cycles.Inaddition,manyresourcecompanieshave
                                                                 6
decliningreserves,largeongoingcapitalspending
                                                                 6
requirements,andregularperiodsofpoorbusiness
                                                                 4
andinvestmentperformance.Apartfromthepast
                                                                 4
fiveyears,commoditypricesineithernominalor
                                                                 2
real(inflation-adjusted)dollarsdidpoorlyoverthe
                                                                 2
previoustwodecades.Indeed,nominalcommodity
                                                                 0
pricesappeartohavecurrentlyreachedclosetosuper-
                                                                     1957
                                                                     1960
                                                                     1963
                                                                     1966
                                                                     1969
                                                                     1972
                                                                     1975
                                                                     1978
                                                                     1981
                                                                     1984
                                                                     1987
                                                                     1990
                                                                     1993
                                                                     1996
                                                                     1999
                                                                     2002
                                                                     2005
                                                                     2008




                                                                 0
normallevels(Figure1).
                                                                        1957
                                                                        1960
                                                                        1963
                                                                        1966
                                                                        1969
                                                                        1972
                                                                        1975
                                                                        1978
                                                                        1981
                                                                        1984
                                                                        1987
                                                                        1990
                                                                        1993
                                                                        1996
                                                                        1999
                                                                        2002
                                                                        2005
                                                                        2008




                                                               Figure 1. CRBSpotMetalsIndex–abasketoffivemetals:
                                                               copper,lead,scrapsteel,tinandzinc–ineithernominalor‘real’
                                                               (USinflationadjusted)terms.Source:MacquarieSecurities.




                                                                                         Industrials & Resources August 2008            1
Today’shighcommoditypricesprovideasignalto                                                Thereisalsoevidencethatmanycommoditymarketsin
producerstoincreaseproduction.Aftersomelag,                                                generalarebeingdrivenbyspeculators.Thisactivityhas
increasedsupplywilleventuallysaturatedemand,                                                theeffectofpreventingtruepricediscovery,meaning
pushingdownpricesinwhatisanaturalcommodities                                             thatmanycurrentcommoditypricesdonotreflect
cycle.Inmetalssuchascopperandironore(Figure2),                                         theirlong-termoutlook,whichismuchmorebenign.
thereisalreadyplentifulevidenceofanimpendingjump                                         Forinstance,thecurrentcrudeoilpriceissignificantly
inproductionthatwillmorethansaturatedemand.                                              higherthanourlong-termpriceassumptionofUS$75
Inoilandgas,thereisasignthattoday’selevated                                            to$80abarrel.Hence,today’shighcommodityprices
energypriceswillslowworldeconomicgrowth,only                                              maynottranslateintopermanentprosperityforthe
hasteningthecycle.                                                                              shareholdersofresourcecompanies.

                                                                                                  Cautious on overexposure to resource stocks
         24          Copper demand                                                                Forthereasonsoutlinedabove,IMLisgenerally
                     Copper supply                                                                cautiousonresourcestocks,especiallywithcommodity
         22
                                                                                                  pricesneartheirall-timehighs.Wethinkthat
         20                                                                                       industrialstocksnowoffermuchbetterlongerterm
                                                                                                  valuethanresourcestocks(Figure3).
MTpa




         18
                                                                                                  Nonetheless,IMLstillholdspositionsinseveralwell-
         16
                                                                                                  establishedresourcestocks,suchasBHPBilliton,Rio
         14                                                                                       TintoandWoodsidePetroleuminitsflagshipAustralian
                                                                                                  ShareFund.Wehaveholdingsintheselargeresource
         12
                                                                                                  companiesbecauseoftheirdiversifiedoperations,
              2000


                        2002


                                      2004


                                                2006


                                                              2008f


                                                                          2010f


                                                                                          2012f




                                                                                                  goodspreadoflong-lifeassetsandthefactthattheir
                                                                                                  reservesarestillgrowingataratethatgenerally
                                                                                                  outstripsproductiongrowth.
       1400          Iron ore demand

       1200          Iron ore supply                                                              Incontrast,manysmaller-capresourcecompanies
                                                                                                  produceonlyonecommodityfromasinglereserve,
       1000                                                                                       makingtheirearningsveryvolatileandhigh-risk(for
                                                                                                  example,BeaconsfieldGold,CroesusMiningand
MTpa




        800
                                                                                                  GympieGold).Alternatively,theycouldbeexploration
        600                                                                                       playswithnoearningsatall.Eitherway,inourview,
                                                                                                  manysmallerresourcecompaniesaredifficulttovalue
        400                                                                                       andveryspeculativeandriskyinnature.
        200
              2002

                     2003

                               2004

                                      2005

                                             2006

                                                       2007

                                                              2008f

                                                                      2009f

                                                                                  2010f

                                                                                          2011f




Figure 2.Globalcopperandironoredemandandsupply.
Source:CopperDevelopmentAssociation;MetalBulletinandIML
estimatesforironore.




2       Investors Mutual Ltd
       Relative 1 year forward price-to-earnings                                                                   Relative 1 year forward EPS growth
2.0                                                                                                          3.0

                                                                                                             2.5
1.5
                                                                                                             2.0
1.0                                                                                                          1.5

                                                                                                             1.0
0.5
                                                                                                             0.5
0.0                                                                                                          0.0
      1998

              1999

                       2000

                                   2001

                                           2002

                                                    2003

                                                                2004

                                                                        2005

                                                                                 2006

                                                                                             2007

                                                                                                     2008




                                                                                                                   1990

                                                                                                                               1992

                                                                                                                                                  1994

                                                                                                                                                                1996

                                                                                                                                                                                1998

                                                                                                                                                                                               2000

                                                                                                                                                                                                                 2002

                                                                                                                                                                                                                                2004

                                                                                                                                                                                                                                                2006

                                                                                                                                                                                                                                                                  2008
       Relative 1 year forward price-to-book value                                                                 Relative 1 year forward dividend yield
2.0                                                                                                          3.5
                                                                                                             3.0
1.5                                                                                                          2.5
                                                                                                             2.0
1.0
                                                                                                             1.5
                                                                                                             1.0
0.5
                                                                                                             0.5
0.0                                                                                                          0.0
                                                                                                                   1994
                                                                                                                          1995
                                                                                                                                    1996
                                                                                                                                             1997
                                                                                                                                                         1998
                                                                                                                                                                  1999
                                                                                                                                                                              2000
                                                                                                                                                                                       2001
                                                                                                                                                                                                   2002
                                                                                                                                                                                                            2003
                                                                                                                                                                                                                        2004
                                                                                                                                                                                                                                 2005
                                                                                                                                                                                                                                             2006
                                                                                                                                                                                                                                                      2007
                                                                                                                                                                                                                                                                  2008
       1995
              1996
                     1997
                            1998
                                    1999
                                           2000
                                                  2001
                                                         2002
                                                                 2003
                                                                        2004
                                                                               2005
                                                                                      2006
                                                                                              2007
                                                                                                     2008




                                                                                                                    KEY:
Figure 3.Relativevalue:ASX300Industrialsdividedbythe                                                           Relative value                                                  1SD above                               SD = Standard
ASX300ResourcesIndex.1yearforwardvaluationoftheASX300                                                        Average                                                         1SD below                                    Deviation
IndustrialandResourceindices.Source:UBS.



Comparative performance                                                                                                                    ASX 300 Industrials
                                                                                                            $2,000
Thesharepriceperformanceofresourcestockshas                                                                                        ASX 300 Resources
nowcaughtupwiththatofindustrialstocks,following                                                                                   ASX 300 Industrials
                                                                                                            $1,500
                                                                                                            $2,000
theverystrongperformanceofthelastfiveyears.                                                                                       ASX 300 Resources
Priortothis,resourceslaggedindustrialsfor28years.
                                                                                                            $1,000
                                                                                                            $1,500
Figure4aisbasedonanequalhypotheticalinvestment
of$100intheASX300ResourceIndexandtheASX300
IndustrialIndexmadeinJanuary1980(thedateofthe                                                      $500
                                                                                                            $1,000
indices’inception).The$100investedintheresource
index(orstocksthatmirroredit)wouldhavenow                                                             $0
                                                                                                             $500
                                                                                                                     1980
                                                                                                                     1981
                                                                                                                     1982
                                                                                                                     1983
                                                                                                                     1984
                                                                                                                     1985
                                                                                                                     1986
                                                                                                                     1987
                                                                                                                     1988
                                                                                                                     1989
                                                                                                                     1990
                                                                                                                     1991
                                                                                                                     1992
                                                                                                                     1993
                                                                                                                     1994
                                                                                                                     1995
                                                                                                                     1996
                                                                                                                     1997
                                                                                                                     1998
                                                                                                                     1999
                                                                                                                     2000
                                                                                                                     2001
                                                                                                                     2002
                                                                                                                     2003
                                                                                                                     2004
                                                                                                                     2005
                                                                                                                     2006
                                                                                                                     2007
                                                                                                                     2008




growntoanominal$1,215(9.16%ayearcompounded).
Ontheotherhand,$100intheindustrialindexwould                                                          $0
                                                                                                            Figure 4a.Comparativereturnsof$100investedinboththe
                                                                                                                     1980
                                                                                                                     1981
                                                                                                                     1982
                                                                                                                     1983
                                                                                                                     1984
                                                                                                                     1985
                                                                                                                     1986
                                                                                                                     1987
                                                                                                                     1988
                                                                                                                     1989
                                                                                                                     1990
                                                                                                                     1991
                                                                                                                     1992
                                                                                                                     1993
                                                                                                                     1994
                                                                                                                     1995
                                                                                                                     1996
                                                                                                                     1997
                                                                                                                     1998
                                                                                                                     1999
                                                                                                                     2000
                                                                                                                     2001
                                                                                                                     2002
                                                                                                                     2003
                                                                                                                     2004
                                                                                                                     2005
                                                                                                                     2006
                                                                                                                     2007
                                                                                                                     2008




haveappreciatedto$1,212(9.15%ayear)(Figure4a).                                                      ASX300IndustrialandASX300Resourceindices(excludingthe
                                                                                                               40%
                                                                                                            reinvestmentofdividends).Source:IRESS.
However,bothfiguresignorethevalueofdividends,                                                          35%

whicharelikelytobe2-3%ayearhigherforindustrial                                                     30%
                                                                                                              40%
companies.Thatmeansthereturnfromtheindustrial                                                         25%
                                                                                                              35%
holdingisunderstatedbythehigherdividendamount.                                                        20%
                                                                                                              30%
Separately,resourcestocksnowrepresent32%ofthe                                                         15%
                                                                                                              25%
ASX300Index,upfrom18%tenyearsago(Figure4b).                                                         10%
                                                                                                              20%
                                                                                                               5%
                                                                                                              15%
                                                                                                               0%
                                                                                                              10%
                                                                                                                      1998
                                                                                                                             1998
                                                                                                                                    1999
                                                                                                                                           1999
                                                                                                                                                  2000
                                                                                                                                                         2000
                                                                                                                                                                2001
                                                                                                                                                                       2001
                                                                                                                                                                              2002
                                                                                                                                                                                     2002
                                                                                                                                                                                            2003
                                                                                                                                                                                                   2003
                                                                                                                                                                                                          2004
                                                                                                                                                                                                                 2004
                                                                                                                                                                                                                        2005
                                                                                                                                                                                                                               2005
                                                                                                                                                                                                                                      2006
                                                                                                                                                                                                                                             2006
                                                                                                                                                                                                                                                    2007
                                                                                                                                                                                                                                                           2007
                                                                                                                                                                                                                                                                  2008
                                                                                                                                                                                                                                                                         2008




                                                                                                               5%
                                                                                                               0%
                                                                                                                      1998
                                                                                                                             1998
                                                                                                                                    1999
                                                                                                                                           1999
                                                                                                                                                  2000
                                                                                                                                                         2000
                                                                                                                                                                2001
                                                                                                                                                                       2001
                                                                                                                                                                              2002
                                                                                                                                                                                     2002
                                                                                                                                                                                            2003
                                                                                                                                                                                                   2003
                                                                                                                                                                                                          2004
                                                                                                                                                                                                                 2004
                                                                                                                                                                                                                        2005
                                                                                                                                                                                                                               2005
                                                                                                                                                                                                                                      2006
                                                                                                                                                                                                                                             2006
                                                                                                                                                                                                                                                    2007
                                                                                                                                                                                                                                                           2007
                                                                                                                                                                                                                                                                  2008
                                                                                                                                                                                                                                                                         2008




                                                                                                            Figure 4b.ResourcesasapercentageoftheASX300Index.
                                                                                                            Source:UBS.




                                                                                                                                                                  Industrials & Resources August 2008                                                                           3
Lower risk
Aninvestorinindustrialstockshasseenasteady                          Inthesetestingtimes,thefatherofmodernsecurity
increaseinthevalueoftheirinvestmentovertime,                        analysis,BenjaminGraham,remindsusthat:“the
meaningthatrisk-adjustedreturnsforindustrial                           riskofpayingtoohighapriceforgood-qualitystocks
stockshavebeensuperioroverthelongterm.In                            -whilearealone-isnotthechiefhazardconfronting
contrast,theperformanceofresourcestockswas                            theaveragebuyerofsecurities.Observationovermany
lacklustreformorethan20years,withonlythevery                       yearshastaughtusthatthechieflossestoinvestors
strongperformanceofthepastfiveyearsmakingup                         comefromthepurchaseoflow-qualitysecurities
forwhatwasalongperiodofrelativelypoorreturns.                       attimesoffavourable[sic]businessconditions.
                                                                             Thepurchasersviewthecurrentgoodearnings
IML’s Funds’ performance                                                     asequivalentto‘earningpower’andassumethat
OurunderweightpositiontoresourcestocksinIML’s                        prosperityissynonymouswithsafety.”
portfolios-forreasonsoutlinedabove–hasimpactedour
funds’performancesoverthelastfewyears.However,                       IML’s portfolios
IMLhasoutperformedagainsttheindustrialindexover                      Byanyreasonablemeasureresourcestockslookfully
tenyears.IMLisstickingtoitsvaluephilosophyandwe                   pricedrelativetoindustrialsonalong-termbasis.To
continuetobelievethatovertime,industrialcompanies                    relentatthislatepointinthecurrentcommodities
willoutperformresourcecompanies.                                          cycleandbuynewlargepositionsinresourcestocks
                                                                             wouldservelittlepurposeinourview.Ourclients
Contrarian view                                                              expectustoapplyaconsistent,conservativeapproach
A‘regressiontothemean’wouldsuggestthat                               thatbestservesgenuinelong-terminvestors.While
industrialsshouldperformrelativelybetteroverthe                       onecanneverbecertain,weareconfidentthatour
nextfiveyears,whileresourcestockstakeabackseat.                    portfoliosofmainlyhigh-qualityindustrialstocks
Ifso,animportantdistinctionliesin‘missingout’                       positionourfundswellforthenextfiveyears.
andhavingalready‘missedout’.Webelievethelatter
scenarioismorelikely:thus,thereislittlethatcanbe                  PreparedbytheIMLInvestmentTeam
donefromthispoint.                                                        (withspecialthankstoMarkWade,IMLEquitiesAnalyst)




Your IML Representatives

Mark Folpp                            Jasmine del Villar                     Wayne McGauley                         Peter Jackson
NationalDistribution                BusinessDevelopment                 StateManagerQLD                      StateManagerWA/SA
Manager                               ManagerNSW                            T: 0732290514                       T: 0893872500
T: 0282240516                      T: 0282240536                       M: 0404012644                       M: 0439887044
M: 0438679966                      M: 0401576385                       wayne.mcgauley@iml.com.au             peter.jackson@iml.com.au
mark.folpp@iml.com.au                 jasmine.delvillar@iml.com.au
Nicole Aubrey                         David Blair                            Jonathan Grigg
NationalAccountManager              BusinessDevelopment                  StateManagerVIC/TAS
T: 0282240518                      ManagerRegionalNSW                   T: 0396789135
M: 0421596524                      T: 0282240519                       M: 0439998434
nicole.aubrey@iml.com.au              M: 0410484389                       jonathan.grigg@iml.com.au
                                      david.blair@iml.com.au




AdviserSupport                                                              InvestorsMutualLimited
     1300551132                                                          Level8,10SpringStreet,SydneyNSW2000

     www.iml.com.au                                                        POBoxH104AustraliaSquare,SydneyNSW1215

	
 mail@iml.com.au                                                             T0292327500F0292327511


Whiletheinformationcontainedinthisnewsletterhasbeenpreparedwithallreasonablecare,InvestorsMutualLimitedacceptsno
responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This
advicehasbeenpreparedwithouttakingaccountofyourobjectives,financialsituationorneeds.Thefactthatsharesinaparticular
companymayhavebeenmentionedshouldnotbeinterpretedasarecommendationtobuy,sellorholdthatstock.AnyestimatedEV/
EBITDA,PEandEPSratiosanddividendyieldsreferredtoconstituteestimateswhichhavebeencalculatedbyIML’sinvestmentteam
basedonIML’sinvestmentprocessesandresearch.

				
DOCUMENT INFO