Investors get chance to pull trigger in a firing market

INVESTORS need to start thinking about what gives them the best leverage to a firing equity market. Since June 4, the All Ordinaries Index has jumped almost 10 per cent and there is a noticeable spring in the step of professional investors. This may be another false dawn for stocks, but investors would be negligent ignoring the possibility of a fresh bull surge.

Whitehaven Coal (WHC)

IT HAS been difficult to make an investment call on the thermal and coking coal play, given the negative news surrounding the $5.20-a-share offer for the company by Nathan Tinkler. The stock is trading at just $3.40, with the market signalling the entrepreneur will fail to come up with the funding. But with the bid process coming to a close, a rare opportunity may be emerging for investors.

If the $5.20 offer succeeds, those buying the stock today will make about 50 per cent quickly. But if the bid fails, the fundamentals will come into play. Under this scenario the stock would initially fall as the market braced itself for a sell-down by Tinkler. Once this concern was dealt with the stock could rally strongly, with analysts valuing Whitehaven between $5.50 and $6 a share, or about 60 per cent above the current level.

Fortescue Metals (FMG)

ANDREW Forrest waded into the market in June and bought about $130 million of stock at $4.85 a share. Since then the iron ore producer has gone on a wild ride, with the stock now wallowing at $4.02. Forrest will not be overly concerned about the short-term machinations of the share price.

Of more concern is the price of iron ore. For some time iron ore producers and analysts believed the bulk commodity's price had a fairly sturdy floor under it of $US115 to $US120 a tonne. Effectively this represented the cost base for many of the Chinese producers. In simple terms it was believed a price below $US115 a tonne would knock out many of these producers, dramatically reducing supply.

In recent days the price has sunk to $US106 a tonne. The catalyst for the decline has been a dramatic slump in steel production in China. This could be a short-term bottom and the price may jump back above US$115, especially if China decides to increase its stimulus spending and ignites activity.

But if the Chinese government does not come to the rescue the fear is iron ore prices could slump to $US90 a tonne. This would be highly uncomfortable for Fortescue. Even though its cost of production is about $US70 a tonne, the company is in the midst of a big expansion program. This will see debt peak at just under $10 billion in the next 24 months. A consistent price under $US100 during this period would make it difficult for Fortescue to pay off its debt under the current arrangements.

A jump in price would see the stock rocket, while a fall below $US100 would see the share price leg down. If the latter happens, the big boys - BHP and Rio Tinto - might expand by acquisition.

Henderson Group (HGG)

THE UK-based funds management group is normally overlooked by investors in Australia who concentrate on local players AMP and Perpetual. This lack of interest may just create an opportunity for investors. Henderson last week reported earnings a share of about 10¢. The result was slightly down on the previous half-year, but this has not unnerved investors, with the stock jumping 20 per cent in the past month. If the company can double its half-year result and earn 20¢ a share for the 12 months to December 2012, it is trading on a P/E of eight times. Historically the stock has traded on a P/E ratio of 11 or 12 times.

In a scenario of a sustained appreciation in global equities, the company could see fund inflows resulting in rising fees and profits. This effectively provides the double whammy of rising earnings due to buoyant markets, together with an expanding PE multiple.

If, for example, the company could lift earnings 50 per cent to 30¢ a share and trade on a multiple of 12 times then the share price would move from $1.66 to $3.60.

matthewjkidman@gmail.com

The Age does not take responsibility for stock recommendations. Readers should seek the advice of a licensed financial adviser.

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