big australian big opportunity

EUREKA REPORT

Back to January 16, 2008 edition


Big Australian, big opportunity
By Charlie Aitken


I believe the whole US recession argument is obscuring the key issue. The simple reality is that the US is not the main driver of global commodity demand. In addition, I remain strongly committed to the decoupling theory based on the view that the urbanisation of the BRIC countries remains independent of economic cycles.

I think resource analysts should look at the strong Chinese economy and the Australian leverage to “Chindia”, rather than the direction of US interest rates or the actions of the Fed.

It is China, the rest of the BRIC economies, and the other developing countries, that are the real drivers of global growth and commodity demand. Last year the developing economies accounted for 75% of global GDP growth. It is worth remembering that an incredible 120 countries out of a world total of a 194 enjoyed growth rates of more than 4% last year. The global economic outlook remains strong.

In addition, the Australian economy, and our resource sector, have significantly more leverage to Chindia than any other OECD country in the world. Bureau of Statistics figures for 2007 show that the value of domestic exports to China rose 26% to $22.8 billion, and to India by 37% to $10.1 billion. It is worth noting that the value of Australian exports to Chindia now exceeds Japan, our number one export destination.

Base metal prices remain very resilient despite US recession fears. Surely they should have crashed. The bulk commodity producers are on the brink of 50% increases in steaming/coking coal and iron-ore contract prices. The oil price is at all-time highs, trading just below $US100 a barrel, and gold has just reached a record high of $US900 an ounce. As a result, I expect resource cash flows to surprise on the upside and the earnings upgrade cycle to remain intact.

In addition, the major resource stocks have corrected between 15–20% and are now trading back at significant discounts to long-term price/earnings (P/E) multiple averages. By any comparison BHP Billiton is the absolute standout at 2007-08 P/E of 10 times, according to figures prepared by Southern Cross Equities analyst David Radclyffe. At this time last year, when there was a similar market meltdown, BHP was $24 and subsequently doubled in price.

I expect BHP to rally $5 if management walks away from the Rio Tinto deal, forcing the arbitrageurs to unwind shorts, or achieve a medium term P/E re-rating to14–15 times, or parity with the broad market multiple, if the takeover is successful. Our 12-month target is $53. Heads you win, tails you win.

I urge investors to reject the constant barrage of short-termist US-centric research, which is obscuring genuine investment opportunities within the resource sector.

Charlie Aitken, a director of Southern Cross Equities, may have interests in any of the stocks mentioned.