BAILLIEU HOLST QUANT RESEARCH 10 March 2016 INTERNAL ONLY Baillieu Holst Ltd ABN 74 006 519 393 www.baillieuholst.com.au Please read the disclaimer at the end of this report. Page 1 RESEARCH ANALYST Mathan Somasundaram +612 9250 8947 [email protected]Equity Resource Engineer ENGINEERING GUIDE TO EQUITY STRATEGY Resource Trade > Buy Gold, Sell the rest Macro outlook: Global growth continues the slide down while major economies are expected to bring back currency war. China has downgraded growth outlook while offering more stimulus options. Europe is expected to take interest rates into further negative territory while Japan is expected to follow the same trend. Global downgrades and rising USD strength continues to weigh on non-precious commodities. Equities linked to non-precious commodities struggle to provide earnings clarity despite the recent bounce from the Chinese New Year. The lack of any supply side action despite falling demand will continue to deliver negative growth outlook. The risk of the US Fed moving on rates in mid-March, the negative outlook for non-precious commodities and the stretched multiples after recent bounce supports the view to reduce exposure and come back when the outlook gets more clarity. Gold sector has moved from buy to hold territory on the back of growth, value and safety aspects. Energy Sector: Remains in the high risk category due to falling global growth, oversupply and historically low ROE at stretched multiples. We struggle to see clarity in the forecasts without supply side action from OPEC countries. Time to take profit and come back when there is change in the demand/supply dynamics. Metals & Mining (Ex Gold): Remains in the high risk category due to declining commodity prices, US Fed action, China risk and weaker global growth. Recent bounce on short covering rally has moved the multiples past the optimistic commodity price assumption levels. The sliding ROE and substantial premium to fair value supports the negative outlook. Time to take profit and come back when there is change in the demand/supply dynamics. Gold: Gold equities (i.e. EVN, NCM, NST and SAR) outlook remains robust with rising growth and ROE from a long term fair value basis. The rising market risk and falling currency will favour Aussie gold miners. The Gold equities have moved from buy territory in December to hold territory in March.
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BAILLIEU HOLST QUANT RESEARCH
10 March 2016 INTERNAL ONLY
Baillieu Holst Ltd ABN 74 006 519 393 www.baillieuholst.com.au Please read the disclaimer at the end of this report. Page 1
Macro outlook: Global growth continues the slide down while major economies are expected to bring back currency war. China has downgraded growth outlook while offering more stimulus options. Europe is expected to take interest rates into further negative territory while Japan is expected to follow the same trend. Global downgrades and rising USD strength continues to weigh on non-precious commodities. Equities linked to non-precious commodities struggle to provide earnings clarity despite the recent bounce from the Chinese New Year. The lack of any supply side action despite falling demand will continue to deliver negative growth outlook. The risk of the US Fed moving on rates in mid-March, the negative outlook for non-precious commodities and the stretched multiples after recent bounce supports the view to reduce exposure and come back when the outlook gets more clarity. Gold sector has moved from buy to hold territory on the back of growth, value and safety aspects.
Energy Sector: Remains in the high risk category due to falling global growth, oversupply and historically low ROE at stretched multiples. We struggle to see clarity in the forecasts without supply side action from OPEC countries. Time to take profit and come back when there is change in the demand/supply dynamics.
Metals & Mining (Ex Gold): Remains in the high risk category due to declining commodity prices, US Fed action, China risk and weaker global growth. Recent bounce on short covering rally has moved the multiples past the optimistic commodity price assumption levels. The sliding ROE and substantial premium to fair value supports the negative outlook. Time to take profit and come back when there is change in the demand/supply dynamics.
Gold: Gold equities (i.e. EVN, NCM, NST and SAR) outlook remains robust with rising growth and ROE from a long term fair value basis. The rising market risk and falling currency will favour Aussie gold miners. The Gold equities have moved from buy territory in December to hold territory in March.
BAILLIEU HOLST QUANT RESEARCH
10 March 2016
Baillieu Holst Ltd ABN 74 006 519 393 www.baillieuholst.com.au Please read the disclaimer at the end of this report. Page 2
Contents Major Sector Outlook – Resources 3 Sector Outlook – Energy 5 Sector Outlook – Metals & Mining (Ex Gold) 7 Sector Outlook – Gold 10
BAILLIEU HOLST QUANT RESEARCH
10 March 2016
Baillieu Holst Ltd ABN 74 006 519 393 www.baillieuholst.com.au Please read the disclaimer at the end of this report. Page 3
Major Sector Outlook – Resources Summary – The Resources sector continues to struggle with the long term negative
dynamics driven by oversupply while short term risk remains with US Fed action. The rise in the USD and potential flow on effects into emerging markets will be negative for commodity prices. Gold and other precious metals are benefitting from the tight supply and demand elasticity with heightened market risk profile. The large miners are expected to remain in downgrade mode and pull back dividend outlook while most of the negative news in small miners are in the price. The Energy sector is a bet on the oil price as the market lacks any clarity on the short to medium term outlook. The recent short covering bounce has delivered a substantial boosted to the multiples that are unlikely to be matched by the commodity price recovery in the next 12mths.
Value – Resources trading at a substantial premium to long term average.
Growth – Sliding ROE to historical low level shows the risk in growth recovery assumption in 2017.
Yield – The gap between dividend yield and bond yield has started to shrink as the main yield players start to downgrade yield outlook.
Risk – Earnings yield to bond yield gap shows risk is at medium level. Falling commodity prices, US Fed move and emerging market growth downgrades are adding to the risk in the sector.
Momentum – Price momentum shoots up to positive territory despite earnings revision falling further into negative territory.
Long term sector charts – FIG. 4-2 to FIG. 4-9.
FIG.1-1: COST OF STYLE
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Cost of Growth Cost of Yield GARY (Growth At Reasonable Yield) S&P 300 Resources ‐ RHS
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Sector Outlook – Energy Summary – Energy sector short covering bounce is likely to be short lived without supply
side action. The OPEC move to maintain oversupply with new entrants suggests that we are likely to remain in oversupply in the short to medium term. The recent low level may see some support after the recent comments from OPEC and non-OPEC producers. The longer term dynamics still remains negative. Declining ROE outlook raises question about the sustainability of the low growth outlook. Small cap energy stocks with solid balance sheet will come back in favour at the recent low levels.
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Sector Outlook – Metals & Mining (ex Gold) Summary – Trading at a substantial premium to long term average despite unsustainable
commodity price bounce. The declining ROE outlooks for big and small miners support the long term negative outlook. Analyst’s optimism in a commodity rebound in 2017 has started to wane in recent months. The downgrade risk remains higher in large miners compared to small miners when comparing growth outlook to valuation on long term basis.
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Sector Outlook – Gold Summary – Gold remains the only commodity with recovering ROE, fair value, solid growth
and protection against US Fed driven global macro risk. The Australian gold miners have delivered solid market updates into the reporting season and are expected to enjoy the benefit of rising spot gold in USD as well as falling AUDUSD. We maintain our positive outlook for gold despite the substantial outperformance in the recent months. Despite the stretched valuations, we expect analyst to upgrade post March on better than expected results and stronger spot gold prices.
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