Before diving into this week’s stock tips, I want to quickly warn you about a potential time-bomb in the market. If, like me, you’re slightly long in the tooth, then the events of Black Monday in October 1987 and the bursting of the dotcom bubble in 2000 will still be indelibly etched in your memory. I recall the City’s irrational exuberance immediately prior to the collapses, and believe that history could be about to repeat itself. Luckily not across the entire market – valuations as a whole appear reasonable – but in certain areas.
It is in the area of low-growth defensive stocks, such as utilities and infrastructure assets, where I feel prices are near unsustainable levels. Partly as a consequence of the mergers and acquisitions boom and of bid speculation by cash-rich venture capitalists, the prices of many “old economy” shares have rocketed. I’m not the only one with this view. Last weekend, the FT reported that GMO, a large US fund manager, said that it thought that “UK value stocks were now at their most expensive since 1969”. It is impossible to call the top of a market, but I do sense that it’s time to take profits on many of these inflated, defensive plays. Clearly, prices could still rise, but with valuations already treading on thin ice, I would suggest banking your profits before the inevitable correction does eventually occur.
Tip of the week: Vedanta Resources (VED, 1,321p), recommended as a BUY by UBS
This is slightly unusual territory for me, as I do not usually recommend commodity stocks because they tend to have minimal pricing power due to their lack of differentiation. However, there are some occasions when, from a pure value perspective, these businesses appear fundamentally undervalued.
Take Vedanta Resources, an Indian-based mining and metals company, which owns extensive copper, zinc and aluminium assets in India and Zambia. It is listed in London with a £3.5bn market cap, and the shares are 54% owned by the Agarwal family. Many metals prices have plummeted some 25% from their peaks earlier in the year, and clearly the volatility has spooked investors. Indeed, Vedanta’s share price has also suffered, falling from a high of 1,740p in May to 1,256p today. However, I think this sell-off is overdone, and presents investors with a good buying opportunity.
This year, Vedanta’s zinc division should contribute nearly 50% of the group’s profits. Unlike copper and aluminium prices, zinc prices have continued to rise in 2006 from $2,000 per ton in January to over $4,000 currently. Furthermore, last week the company unveiled ambitious plans to move into the Indian energy market, starting with the construction of a $1.9bn coal-fired power station in the state of Orissa. The City’s reaction was muted and duly marked the shares down. However, I think Verdanta could be making a very smart move. GDP is growing by over 8% a year in India, and there is a huge shortage of reliable electricity: the finance ministry estimates that power shortages alone are costing the nation 10% of its potential productivity. The investment could also provide Vedanta with access to India’s substantial coal reserves, which are due to be sold off by the government. If the group manages to add coal mining to its already extensive metals portfolio, then there could be further upside.
Finally, at last week’s interims, Vedanta reported impressive revenues and earnings per share of $3bn and $1.56 (or 82p) respectively, driven by improved prices and greater operational efficiencies. Analysts are predicting earnings per share for this year and next to be 190p and 180p – putting the shares on corresponding p/e multiples of only 7.0 and 7.3. The balance sheet is also sound with net cash of $216m.
With the City undecided about the wisdom of moving into power generation and also concerned with Vedanta’s exposure to fluctuating commodity prices, political interference and environmental pollution, I believe that the shares have been unfairly sold off. Therefore, as long as you’re prepared for a relatively bumpy ride – in line with the rest of the mining sector – then I think that the shares offer good value for the long-term investor, given Vedanta’s enviable position in zinc and its strong operations in India.
Recommendation: BUY at £13.21