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PREVIOUS ARTICLE Dingoes Of The ASX 50 NEXT ARTICLE Stock of the Week - 6th March 2011

Consensus forecasts expect the S&P/ASX200 to grow by around 10 per cent in 2011 to around 5500 points excluding dividends, with the bulk of this growth coming from the mining sector alone. Based on Paterson Securities figures, the mining sector will deliver overall earnings growth of 75.2 per cent this year, followed by transportation (63.1%), consumer services (23.0%), steel (20.1%), utilities (16.7%), and gold (15.7%).

But given that many of these numbers follow a bout of decidedly low earnings a year earlier, investors need to set these figures in context. Kien Trinh quant analyst with Patersons says longer term investors should look closely at the numbers over the next couple of years.

Having been hit by a raft of earnings downgrades, industrials are only expected to contribute 6.6 per cent growth in 2011, but this figure is set to double the following year. By comparison, he expects a huge reduction in earnings from mining in 2012 – to around 27 per cent – as commodity prices soften from their historical highs. Nevertheless, steel earnings are expected to jump from 20.1 per cent this year to 74.3 per cent in 2012.

Equally important, Trinh also says investors need to recognise that the gyrations on year-on-year performance might be due to a sector’s over exposure to a few ‘weighty’ stocks. Oil & gas and transportation serve to illustrate the point, but there are many other sectors displaying similar nuances.

Trinh expects much of the transportation sector’s expected 63 per cent earnings growth this year to be attributed to stocks like Qantas (QAN) coming off a low base the year before. Following last week’s four-fold profit rise of $241 million, the airline is forecasting an 11 per cent increase in capacity in the second half of 2010/11. Conversely, earnings for the oil & gas sector are only expected to grow by a paltry 2.9 per cent this year. Much of this can be attributed to predominance of Woodside (WPL), which most brokers have a bearish outlook on.

Excluding Woodside, Trinh expects energy to be the third best sector in 2011 with earnings growth of around 25 per cent. “Growth is also expected to pick up significantly next year in steel – notably, One Steel (OST), Bluescope Steel (BSL), and Sims Metal (SGM); Mining services – Leighton Holdings (LEI), Boart Longyear (BLY), Ausenco (AAX), Macmahon Holdings (MAH); Insurance Suncorp (SUN); Diversified financials Macquarie Group (MQG); and building materials – James Hardie (JHX), and Boral (BLD),” says Trinh.

Trinh says marked swings in year-on-year sector earnings should serve to remind investors of the cyclical nature of earnings, especially for industrials within what remains a ‘stock pickers’ market. He says one of the best ways for investors to normalise the current gyration in earnings is to keep a close eye on price. Earnings growth aside, he says investors should be equally fixated on unearthing value plays often overlooked within the numbers.

With forward price to earnings ratio for Australian shares currently at 13 times – compared to a longer term average of 14.6 times – valuations across the market still look attractive. Based on Trinh’s projected EPS growth over the next two years, and discounted price to earnings (P/E) – relative to their industry peers – he says there are currently seven standout value-plays across a handful of sectors, these include (see table below): Three mining stocks – BHP Billiton (BHP), Rio Tinto (RIO), Fortescue metals Group (FMG) which Trinh expects to deliver 60 per cent EPS growth; Services companies Bradken (BKN), and Alesco (ALS); plus the Bank of Queensland (BOQ) and One Steel (OST).

We asked brokers to provide their top picks across key sectors expected to outperform this year.

David Wall, Analyst Oil & Gas, Hartleys

Rising oil prices is the tide that will float most boats in the sector, but given that softening demand can stifle growth, it doesn’t always find its way to the share price. We expect two subsectors – non-conventional liquids, and the conventional high-risk speculative end to benefit most.

Key picks – Energy

1)    Samson Oil & Gas (SSN): Holds extensive development and exploration acreage in the US, currently trading at around a 50 discount to Wall’s $0.20 target.

2)    Texon Petroleum (TXN): An oil & gas explorer/producer with its operations located in the Gulf Coast of Texas, trades at 77.5cps

3)    Far Ltd (FAR): With oil & gas interests in Australia, Canada, Offshore Senegal, and Guinea FAR remains a speculative buy at prices below 12cps ahead of drilling at the Kora prospect, currently trading at 14cps.

4)    Sun Resources (SUR): WA-based oil and gas exploration/ production company trading at 6cps.

5)    Cue Energy (CUE): Share price (33cps) could be 50 per cent higher based on limited downside and upside to drilling at Caterina of which Woodside has a 65 per cent interest, trades at 33.5cps.

6)    Octanex (OXX): Currently drilling at two of the numerous working petroleum exploration interests in offshore basins in Australia and NZ, trades at 60cps.

7)    Oil Search (OSH): As a junior partner with ExxonMobil’s $6 billion LNG project in PNG, OSH could benefit handsomely, provided sales contracts are nailed down ahead of rival projects, trades at $7.03.

John Young, Analyst resources, Wilson HTM

Resources to continue outperforming based on a favourable mid-term outlook for commodities.

Key picks – Resources

1)    Allied Gold (ALD): A substantial increase in group gold production from around 75kozpa, to 220kozpa annualised by early 2012 is expected to re-rate the stock. Trading at a 53.5 per cent upside to Young’s $0.94 target.

2)    Red 5 (RED): H1 CY2011 will see the company transit from explorer/developer to gold producer with the first gold pour expected in May. Trading with a 99.6 per cent upside to Young’s $0.37 target.

3)    Hillgrove Resources (HGO): Still represents a valuable exploration option play through the company’s Bird’s Head and Sumba Island projects in Indonesia. Trading at a 102 per cent upside to Young’s $0.64 target.

4)    Atlas Iron (AGO): Provides exposure to a northern Pilbara iron ore producer with an ambitious production growth profile. The proposed takeover of GIR is attractive to both AGO and Giralia Resources (GIR) shareholders, with synergies for northern Pilbara, and other operations. Trading with a 44 per cent upside to Young’s $4.55 target.

5)    Iluka Resources (ILU): Provides exposure to global growth in zircon, and titanium dioxide (TiO2) minerals. Trading with a 23.2 per cent upside to Young’s $11.21 target.

6)    Macarthur Coal (MCC): Provides best leverage to a recovery of coal production to meet steel market demands through LVPCI coal demand. Trading with a 16.2 per cent upside to Young’s $15.01 target.

7)    Bow Energy (BOW): Rerating catalysts include achieving commercial flow-rates at its Blackwater and Norwich Park projects, conversion of 3P to 2P reserves and securing major gas supply contracts. Trading with a 51.9 per cent upside to Young’s $1.80 target.

8)    AWE (AWE): Oversold following disappointing exploration results in CY10, with existing producing projects worth more than the current share price and upside potential from the onshore Perth Basin shale gas. Trading with a per cent 33.9 upside to Young’s $2.35 target.

9)    Sundance Resources (SDL): Provides exposure to growing reserves and production in US shale oil where advances in fracturing technology have significantly improved Bakken well economics. Trading with a 10.5 per cent upside to Young’s $0.84 target.

Kien Trinh, Quant analyst, Patersons Securities

Key picks – Consumer Services and Miners

Earnings growth is expected to be strongest in mining, transportation and consumer services while lacklustre growth is forecast for telecoms, property, building materials, diversified financials, and insurance. Chinese growth and a slow US recovery add attraction to the recovery/inflation trade in metals.

A)    Consumer services

1)    Wotif (WTF): The online accommodation and travel booking website, negatively impacted by Qld floods, but will benefit from competitive airline pricing, trades at $4.44.

2)    Cabcharge Australia (CAB): Interim net profit declined 9 per cent on a year-on-year basis, to $29.5m, but a notable improvement in business confidence bodes well for the taxi-charge operator, trades at $5.75.

3)    Fleetwood Corporation (FWD): Builds caravans, popular among ‘grey nomads’, and mobile accommodation for mining contractors, trades at $13.98.

B)    Mining

1) Fortescue Metals Group (FMG): Australia’s third-biggest iron ore miner reported a 9 per cent rise in iron ore production to 9.93 million tonnes in the December quarter, trades at $6.96.

2) Rio Tinto (RIO): Offers the cheapest way to get iron ore exposure, underlying earnings came in at $13.99bn, up 122 per cent from last year, in line with analysts’ expectations of $14.1bn. Iron ore demand is expected to outpace consensus expectations in 2011 and 2012, currently trading at $87.39.

3) Alumina Ltd (AWC): 2010 net profit of US$35 million, up from 2009’s US$24 million. CEO John Bevan expects the market for alumina to grow by 12 per cent in 2011, trades at $2.52.

4) Newcrest (NCM): Australia’s biggest goldminer, NCM has boosted its half year net profit by more than 96 per cent based on record gold production, trades at $38.96.

5) St Barbara (SBM): The WA gold producer and mineral explorer, plans to become a 500,000 ounce-a-year gold miner by 2014, trades at $2.05.

6) Avoca Resources (AVO): Cashed in on high gold prices and the integration of Dioro Exploration to forecast a 53 per cent increase in revenue, trades at $3.30.

7) OceanaGold (OGC): The NZ and Philippines-based gold producer expects its operating results before abnormal items and income tax to be up by more than 15 per cent from the previous period, trades at $2.85.

8) Kingsgate Consolidated (KCN): A low cost gold producer which owns and operates the Chatree gold mine in central Thailand through its Thai subsidiary, Akara Mining Limited, trades at $9.75.

Ian Myles, Analyst, Macquarie Securities

Key picks – Transport and utilities

Utilities are likely to deliver more than the market return, but since earnings are wired to a regulated base, they won’t provide any recovery upside. Given that they’re not exposed to price and are only leveraged to volume, airports are favoured over airlines in the transport space.

A)    Utilities

1)    MAP Group (MAP): Traffic growth at Sydney Airport after last year’s 7.8 per cent rise in passengers saw the airport owner deliver a 12.1 per cent increase in full-year earnings, trades at $3.15.

2)    AGL Energy (AGK): Strong growth potential exists within the retail and power generation businesses and the upstream gas portfolio which should deliver above average shareholder returns over the medium term. An estimated P/E ratio of under 13 times, makes it look cheap given the strength of the core business, trades at $14.78.

3)    Macquarie Atlas Road Group (MQA): Expected to shift from speculative to high-grade investment within 12 months, suits tax advantaged investors, target of $2.20 will move closer $3 following further de-risking. Further upside from a weakening A$ against the Euro.

B)    Transport

1) Brambles (BXB): The pallet supplier and information management firm recently acquired Container and Pool Solutions (CAPS) – a provider of intermediate bulk carriers and automotive containers which achieved 14 per cent compound annual sales revenue growth over the past six years, trades at $7.32.

2) Asciano (AIO): Favourable bulk growth drivers, ‘take or pay’ contracts and strict internal return hurdles of 15-18 per cent mean earnings growth is more certain than other cyclicals. Positive catalysts include bulk rail contract momentum and volume recovery in the containerised and automotive divisions, trades at $1.72.

3) Toll Holdings (TOL): A logistics company is a recovery-play wired to an improving domestic economy, trades at $6.29.

 

 

STOCK

CURRENT P/E

 EPS GROWTH % 2 YEARS

EPS GROWTH % 2 YEARS

 GROSS YIELD
 BHP 12 15 30 3%
 FORTESCUE 11 15 60 0
 RIO 12 15 56 1.5%
 BRADKEN 13 18 17 6.3%
 BANK OF QLD 11 12 20 8%
 ONE STEEL 11 21 40 4.5%
 ALESCO 13 16 40 3%

 Source: Patersons Securities

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