There is an old maxim about the stock market that it makes sense to invest at the time of “maximum pessimism”, typically when the market is panicking and selling shares in a climate of near hysteria.
That’s happening right now in our mining sector, which for so long has been the best performer on the Australian market.
Poor economic data out of China – particularly its industrial production numbers (the best indication of the level of demand in China for Australian commodities) have seen the price for iron ore fall by around 30 per cent in just one month – an almost unheard of slump.
As a result, almost all mining stocks have seen their share prices plummet. The sell off has also hit mining services companies, those firms that provide a range of goods and services to the big miners, because investors fear they will fall victim to radical cost-cutting exercises.
While this is certainly a genuine concern, the crowd-like selling mentality has lumped all mining stocks together in a wave of negative sentiment, instead of judging each individual stock on its merits.
Our detailed analysis of one company in particular, Mineral Resources Ltd, has given us confidence that this company does indeed present a good buying opportunity.
Mineral Resources is an integrated supplier of goods and services to the resources sector, with diversified activities across contracting, processing and commodities production. The company has a portfolio of businesses including PIHA pipelines, Crushing Services International, Process Minerals International, Polaris Metals and Mesa Minerals. It has a market capitalisation of $1.5 billion.
It recently released results showing net profits after tax were up 61% for the year, with a range of other financial measures showing the company is in excellent health. It is even paying a dividend of over 5%.
Crucially, it has recently signed a 10-year crushing contract with Fortescue Metals which will be a big driver of its earnings going forward.
However, because of the recent slump in iron ore prices (iron ore accounts for 100% of Fortescue’s revenues), the market has got the jitters. In fact, at current levels, Mineral Resources is almost being priced as if Fortescue was going out of business. We do not think this is a likely outcome.
The trigger for a recovery in MIN’s share price will be a recovery in the iron ore price or a reassessment of Fortescue’s prospects.
Whether that will happen in the short term is anybody’s guess, but we still believe that the industrialisation and urbanisation of China - and other emerging economies - will continue, albeit with some bumps along the way. With that in mind, if China releases some better data, the iron ore price should respond, lifting iron ore-related miners and their share prices with it.
If you are prepared to take a gamble that China will indeed bounce back, then Mineral Resources Ltd is a great way to leverage your exposure and benefit from what should be a sharp rebound. Based on our analysis, we have a target price of $11.34, which would give investors who buy today a healthy 40 per cent gain.
Company: Mineral Resources
Current price: $8.07 (Sep 17)
Forecast value: $11.34 and above ++
Potential upside: 40.5%
Readers of Yahoo7 Finance can obtain a free 14-day trial offer of the MyClime online share valuation and research service at www.clime.com.au.
Investors should not rely on this information alone and should seek independent financial advice from a qualified expert before considering any share market investment.
++Fair or forecast value is the price placed on the share after calculating a range of factors including profitability, assets, debt and, most importantly, Return on Equity – the same measure used by Warren Buffett to assess long-term value.
Shares are assessed by Clime Asset Management to calculate which companies are undervalued or over-valued based on their return on equity. History has shown that the most successful companies are those that produce the highest returns per dollar of shareholders' equity, yet this is not typically how shares are valued. This system highlights shares that are undervalued on this key measure. Shares are expected to reach this value in 3-5 years, as price tends to follow value in time.
Information is intended as a guide only. For specific advice contact your financial services professional.