Market Predictions

Value managers punt resources over construction shares

What's hot and not

Some of the hardest hit stocks on the Johannesburg Stock Exchange in 2012 have been those in the resources and construction sectors. And while there is an overlap between these two sectors in terms of business cycles, value manager RE:CM says that of the two, it is only certain resources counters that currently offer value for investors.

“As bottom-up value investors, it is important to realise where a business is in its business cycle,” says Richard Court, analyst at RE:CM. “When businesses are experiencing headwinds, the economics of that particular business generally suffer, leading to poor returns. However, market participants have this uncanny ability to overreact to cyclical influences, which leads to the price of shares in that business trading at a discount to its intrinsic, through-the-cycle value. This provides an opportunity to acquire this business at a discount.” 

Court adds, however, that the decision whether or not to buy a business is not solely dependent on its position in the cycle, but is made based on the discrepancy between the intrinsic value and the price of the business. 

“It does happen that businesses faced with cyclical headwinds do not become cheap enough to provide an attractive investment opportunity.” 

He says the share prices of South African construction stocks provide a good example of this situation. “For example, at the height of the construction boom, Murray & Roberts traded on a price-to-book value multiple of six times. Compare this to its long-term average price-to-book value multiple of 1.5 times, which is where it is currently lying. This indicates that it is fairly valued at present and illustrates how far the share price needs to fall from its highs before it becomes cheap.”  

In comparison, Court says a business such as Anglo Platinum – which historically earns returns on equity well in excess of its cost of equity – is trading at low multiples very rarely seen before, indicating the value on offer in particular businesses in the resource sector.

“This is why RE:CM has allocated capital to businesses in the resource sector, specifically the platinum sector. With the demand-supply dynamics placing serious downward pressure on the price of platinum and leading to margin squeeze and losses, capital is flowing away from the platinum producers – resulting in an attractive investment opportunity in these businesses.” 

According to Court, an additional consideration is the sustainable competitive advantages prevalent in the businesses in each sector. “The resources sector has some potential sustainable competitive advantages such as the market share of Anglo American or the quality of the resource at Impala Platinum. The construction industry, on the other hand, has very low barriers to entry, hence the number of new entrants in the market during the boom.” 

He says that within the resources sector, RE:CM currently favours Anglo American Platinum, Impala Platinum and Lonmin. “Anglo American is a diversified miner with a significant exposure to the platinum industry through its shareholding in Anglo Platinum. Anglo Platinum is the largest platinum producer in the world, followed by Impala Platinum and Lonmin. It is noticeable that the common thread between these businesses is the exposure to the platinum industry.” 

Court adds that currently, while RE:CM’s clients do not own any of the large construction businesses, they do have some exposure to the construction cycle. “Sixty percent of steel produced in South Africa is used in the construction industry and ArcelorMittal SA dominates this market. When the construction cycle turns, Arcelor Mittal should benefit from the tailwinds.” 

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