The share prices of resource stocks have drifted and in some cases crashed to levels that are veritably mouth-watering to plenty of resource bulls. Many have lost a quarter of their market value from just six months ago, some like Alumina (AWC) even more, down 40%.
Here is a list of 12 Major Resources Stocks on ASX which we follow continuously: BHP, ILU, OZL, NCM, NHC, STO, WPL, FMG, AWC, OSH and ORG
There are some surprisingly discounts in the resources sectors. Yet as always it is very difficult for investors to acknowledge these discounts because of the negative news in the bigger market.
That being the case we ask which resource stocks allow us to sleep better at night, even in the event things might get worse?
We use a variety of factors to compare these companies.
Market Capitalisation
History shows it is advantageous to have a larger market cap when times get tough. In the sharemarket term, there is a term called “Too big to fail”, although not always works, large companies can survive much better in down markets.
Shares of larger companies are generally more liquid allowing easier exit should it be needed.
Bigger companies also find a more welcoming reception should re-capitalisation be required. They often have a greater selection of assets for fire-sale or selective sell-down in a crisis.
They characteristically have a greater proportion of productive assets to development assets – cash generators versus cash consumers.
Customers and suppliers prefer their business. It is large, repeat and backed by a bigger balance sheet. Simplistically larger companies have more value to lose which buys time.
We've ranked our top 12 companies by market capitalisation from largest, BHP Billiton (BHP)and Rio Tinto (RIO)- $200bn and $130bn respectively - to smallest OZ Minerals (OZL)and Alumina (AWC), each under $4bn. At $15bn Fortescue Metals (FMG)is the largest in the mid tier while Woodside Petroleum (WPL)$27bn leads in the energy space. Size isn't everything but it can help.
Gearing
If your market focus is on the downside, the experience of companies during the GFC is illustrative of the benefits of a strong balance sheet.
At 22% net debt to equity at end FY08, BHP was modestly geared and sailed through the GFC unscathed, perhaps even enriched.
RIO was debt laden, net debt to equity 180%, following its acquisition of Alcan and its share price was squeezed.
RIO eventually came out ok, though shareholders nerves were tested. Its large market cap and a balance sheet replete with quality assets staved off disaster. After taking its medicine in the GFC, RIO is now placed to avoid the stress with conservative gearing.
Our ranking by net debt to equity places New Hope Corporation (NHC)in the most comfortable position with net cash, and FMG in the hot seat, gearing pushing 100%.
Outside FMG, the high growth energy companies are the most balance sheet stretched led by WPL and Oil Search (OSH)with ambitious LNG growth plans. Santos (STO)is the most conservatively geared of the energy stocks.
Interestingly, some analysts suggest that too much cash has a tendency to burn holes in management pockets and a lazy balance sheet is not necessarily driving the returns shareholders deserve.
OZL is another of the cashed-up companies. Note Iluka's (ILU)rapid move to net cash as cash flow balloons, raising the prospect of atypically attractive dividends.
Interest Cover
In addition to gearing it's also worth a look at a company's ability to service those debts. Clearly NHC, OZL and ILU are in comfortable position as they are debt-free.
The negative stand-outs in this stress test are FMG, WPL, Origin Energy (ORG)and AWC. These companies have the lowest ratio of FY12 EBIT to net interest expense at 5.3, 6.5, 6.1 and 11.6 respectively.
Note ORG has utility businesses with very stable cash flows and its integrated business model is innately hedged.
WPL has low FY12 interest cover but is at the end of its Pluto investment cycle with new cash flow coming in. Debt will begin to be repaid in FY12.
STO has higher FY12 interest cover at 25 times but is at the start of its Gladstone LNG project investment cycle with years of capital expenditure before the cash flow payoff. Still this measure has validity if the concern is for worsening near term economic conditions.
Interesting OSH comes out looking better on the basis of interest cover than it does looking at gearing alone. It has strong cash flows from the oil business support higher debt levels.
AWC on the other hand doesn't look badly placed in a gearing sense but shows some vulnerability with aluminium margins wafer thin.
Profit Margins
Investors should consider the susceptibility of earnings to commodity price volatility. Here we look at EBITDAX margins.
We choose EBITDAX because in a crisis capital expenditure can be wound back, as can (X) exploration, at least temporarily.
Like all other measures though margins can be misleading. Price volatility varies across commodities and in the long term differences in capital intensity and returns become increasingly meaningful.
The oil and gas companies are the highest margin businesses in our sample group. But while operating costs are low versus revenue, capital intensity is typically high, especially in the LNG space.
OSH has the highest margins given its liquids rich production profile, followed by WPL around 80% with oil and LNG. STO is lower at circa 60% with a higher proportion of gas, particularly domestic gas which attracts lower prices. ORG has the lowest margins but is an energy retailer, not an exploration and production (E&P) company. Comparisons are not fair given utility style earnings.
Blue chip miners own some of the globe's best assets and as a group generate the second highest margins of our sample at around 45%. The mid tier miners generate lower margins on mass though pace-setters OZL and ILU are generating plus 50% returns.
Earnings Multiples
On a sector basis, the energy stocks trade on the highest earnings multiples. The combined average FY11/FY12 PE of 35 times reflects expectations for substantial growth via LNG projects.
This is particularly so for OSH where PNG LNG development comprises the lion's share of value. High PE stocks are typically vulnerable to price correction when the market turns south.
This possibility is lessened for oil and gas companies given the need for energy in society, particularly gas. Heating and power generation are more resilient than other parts of the economy.
The blue chips and mid tier miners have softer growth priced in with lowest PE stocks BHP and RIO, and ILU and FMG heading up each group respectively, all at single digits.
Conclusion
While using these factors may not provide the best analysis on resources companies, as each company’s asset is different and at different stage of development. By using these analysis, it is interesting to compare the different strategies adopted by companies respectively.
2012 could be a good year for the oil and gas companies as their projects are towards completion with strong cashflow expected to come in. Our view is the oil and gas companies may perform better in uncertain times as they are less volatile to the commodities. However, mining companies are now trading at lowest P/E ratio in many years, and they are some of the cheapest stocks to invest at moment.
