Home' Australian Resources and Investment : March 2010 Contents AUSTRALIAN RESOURCES & INVESTMENT • MARCH 2010 • 21
STOCKS TO WATCH
As bottom-up fundamental investors, we see great opportunities for
value investing going forward, particularly those companies that are
mispriced due to ‘expectations’ driving short term sentiment. Look for
strong Financial Health, which is Lincoln’s first ‘Golden Rule’ for
successful investing. Financial Health, as always, is built on steady cash
flows, stable balance sheets and reliable profits. Also look for
management that delivers good earnings growth and return on assets,
the second ‘Golden Rule’. And, depending on the amount of money you
invest, look for sufficient liquidity and market capitalisation so that you
can move in and out with safety.
Unfortunately, owing to the inherently speculative nature of much
mining and mineral exploration activity, most companies in the
resources sector do not enjoy strong Financial Health, according to
Lincoln’s criteria. These companies, most of which are in the small to
mid-cap space, sometimes do offer the most opportunity for share price
appreciation, but they also provide the most opportunity for investor
Apart from a number of examples, notably in the coal and coal
seam gas spaces, industry Price to Earnings (PE) multiples are at
medium-term lows of around 12 and 13 times. Average yields, for those
miners that do pay dividends, are also higher than usual and with the
relative bounce-back in commodity demand between the six months to
December 2009 and the previous corresponding period, PE to growth
ratios (PEG) are also relatively low, which means that earnings growth is
a cheaper commodity than it once was. Every positive result that is
promptly ignored by the market is an opportunity for us to buy-in at
lower PE multiples and, if applicable, to also enjoy higher dividend
BHP BILLITON LIMITED (BHP)
BHP obviously rates in terms of balance sheet strength being in a
Strong Financial Health position and recently announced a strong
interim result. With record production levels achieved at a number of
projects, it is leveraged highly to the world recovery and improving
commodity prices across the board. BHP’s improved production result
was reflected in a strong earnings result, despite coming in lower than
the previous corresponding period.
EQUINOX MINERALS LIMITED (EQN)
While the company does not have a long history of strong performance,
the development and production schedules for Lumwana have all been
met and expectations so far have been met and exceeded with
improving production every quarter. Low debt and improving profits
result in a Satisfactory Financial Health for EQN. With copper prices
rising, a low cost mine with a long mine life like Lumwana is attractive
at this stage of the cycle. The company’s annual report should be strong
and illustrate improved earnings, but expect this result to continue to
improve with copper prices as the company strives to achieve full
capacity production at this project.
ENERGY RESOURCES OF AUSTRALIA LIMITED (ERA)
ERA produced a mixed result recently where annual production for 2009
had fallen 2% compared to 2008. However, stronger uranium oxide
prices realised in 2009 somewhat offset this. Production rates are
expected to improve mid 2010 with the completion of mine sequencing.
In 2009 ERA’s revenue and profit increased 55% and 23% respectively,
and with a strong rating for Financial Health we believe ERA offers an
opportunity to be exposed to a longer term return to favour for
LIHIR GOLD LIMITED (LGL)
LGL should produce a strong result when it releases its annual results.
Currently in a strong position of Financial Health, the company
highlighted its record gold production result of 1,123 ,759 ounces.
Production for 2010 is forecast to be between 960,000 and
1,060,000oz, therefore growth going forward will be predominantly
determined by gold price movements. Of further interest, the
resignation of CEO Arthur Hood amid criticism of his 2007 acquisition of
the Ballarat goldmine will be an interesting side act.
ERA, LGL and EQN are all Lincoln ‘Star Stocks’. To be a Star Stock, a
company has to have ‘Strong’ or ‘Satisfactory’ Financial Health,
according to our analysis of key ratios in their profit and loss, balance
sheet and cash flow statements, as well as strong earnings per share
growth of at least 8 per cent per annum and annualised return on
assets of at least 8 per cent as well.
BHP, with its Strong Financial Health, and 19.62 per cent return on
assets to the last financial year, is also robust. Currently our preferred
coal stocks are Centennial Coal Limited (CEY) and Macarthur Coal
Limited (MCC). Both are financially healthy, growing earnings strongly
and expected to continue to benefit from a strong outlook in the short
term for the coal sector.
WHAT’S ON THE MENU GOING FORWARD
Beyond value investing, 2010 also presents opportunities to get on
board with some emerging sectors and continuing trends. Lithium will
likely remain in the headlines, as will rare earths, as consumers and the
industry look to new non-carbon sources of power and the continued
need for new battery and fuel cell technologies. We see uranium rising
in sentiment as the same dynamic that caused prices to spike in 2007
returns to the fore. That dynamic – a medium to long-term prediction of
energy demand in a post-carbon world – should also make geothermal
stocks attractive in the coming year.
Expect opportunities for value amid a confused and choppy market,
plus some emerging and continued trends for commodities that play
into the climate change story. As always however, consider fundamental
values when choosing a stock within an investing theme.
Notwithstanding the usual Financial Health warnings, a rich menu of
opportunity awaits this earnings season. Bon appetit.
Lincoln is Australia’s premier fundamental analysis research house
and fund manager offering intelligent sharemarket solutions for the
Elio D'Amato, CEO, Lincoln Indicators
Phone (03) 9854 9444 Mobile 0401 032 914
Lincoln Indicators Pty Ltd ACN 006 715 573 (Lincoln) AFSL 237740. This information is current as at 15 February
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