Paul Hill, one of Britain’s most successful private investors, picks the best tip from the week’s press and broker reports. This week, the environment for commodity stocks may be getting tougher but the outlook for one miner in particular remains positive.
Tip of the week: Xstrata (XTA), tipped as a BUY by UBS and Deutsche Bank
Last week, Xstrata, one of the world’s top five miners, reported record 2006 results. Helped by rising base metals prices and the audacious C$20bn takeover of Canadian rival Falconbridge, revenues jumped 56% to $26.9bn, while earnings per share soared 104% to $5.13. The majority of the profits came from copper (53%), zinc/lead (20%), nickel (11%) and coal (11%). Yet even after these stellar figures, there is barely any City support for miners, which typically trade on current year p/es of eight to ten.
Yes, the environment for commodity stocks is getting tougher as investors fear a slowdown in the global economy and with geopolitical concerns in South America. But Xstrata chief executive Mick Davis remains upbeat. The outlook for metals “remains positive”, he says, and 2007 should be another “very good year”. He thinks that the rapidly industrialising BRIC (Brazil, Russia, India and China) countries, and the gradual pick-up in the older Asian tigers and Europe, should continue to drive demand, despite a decelerating US economy. Also “the supply side will remain constrained due to the lack of major new discoveries, shortages in skilled labour, and the continued depletion of reserves across the industry”.
Xstrata’s management is one of the sector’s best, conducting a series of astute acquisitions, while keeping a tight rein on costs. For example, Falconbridge has been successfully integrated after just six months, generating annual synergies of $545m, up from $120m when the deal was announced. On this year’s shopping list is Xstrata’s next big acquisition, together with the disposal of its non-core US aluminium unit, which is thought to have a price tag of more than $1bn. Xstrata said it has not yet found the right target, although there are rumours that it is circling LionOre Mining, a Canadian nickel producer valued at £1.5bn.
City consensus expects 2007 earnings per share to come in at 296p, putting the shares on a forward p/e of around 8.2. Although this is in line with its peers BHP Billiton and Rio Tinto, it offers good value for the thicker-skinned investor. In fact, as long as you have a diversified portfolio, I would recommend buying shares in all three of these miners, simply on the basis that the City is probably taking an overly negative view on commodity prices. Sure, mining stocks are volatile, but at these levels the risk is more than outweighed by the potential rewards.
Recommendation: BUY at £23.01