Rudi’s View: August Results – First Blood

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Aug 11 2022

In this week's Weekly Insights:

-August Results: First Blood
-September Index Rebalancing (Updated)
-Conviction Calls
-FNArena Talks
-Australian Banks Worried (Behind The Curtains)

By Rudi Filapek-Vandyck, Editor FNArena

August Results: First Blood

The August corporate results season is officially more than one week old, but the FNArena Monitor still only contains 11 updates. A lack of sufficient qualified accountants, apparently, pushes the bulk of corporate releases in Australia into the final two weeks of the month.

But the opening salvo this year, including the preceding fourth quarter updates by miners and energy producers, has already provided some valuable insights which might prove prescient of what is yet to be unveiled over the coming three weeks.

So let's start with some of the insights that should come in handy as Australian investors prepare for the seasonal tsunami in corporate updates.


Members of the Australian Shareholders Association (ASA) in Busselton, WA (*) looked a bit puzzled when I told them in May this year: you do realise that producers of copper, gold, oil & gas, and other commodities are themselves heavy consumers of diesel, steel, water, power, and other commodities?

That reality soon started to show up in quarterly production updates from miners and energy producers. And one sector on the ASX that has been heavily hit are the local gold producers, if only because gold has largely traded sideways this year, apart from a temporary spike as Putin's army crossed the border with the Ukraine.

Rising costs when the price of your main output refuses to spike higher can only mean one thing: margin pressure, and lower profits.

Post-April, the sector has had a rough time. While the return of market optimism in July has seen many share prices rallying off their lows, most prices are still nowhere near the levels witnessed earlier this year. Shares in Newcrest Mining ((NCM)), by far the largest producer in this country, are still trading some -35% below their $29-peak in April.

And so it was, when sector analysts at Canaccord Genuity updated their modeling and forecasts at the end of July, a lot needed to be accounted for as higher costs translate into higher investments for those companies looking to expand and into higher operational expenses when running daily operations.

Consider the following incomplete list of price increases the industry is dealing with:

-Diesel costs up 60% on average in WA
-Steel prices are up 60% from one year ago
-Freight costs can be up to 400% higher
-Costs for drilling have increased by 15-20% in recent months

No surprise thus, running higher operational costs and capex estimates through its modeling, Canaccord Genuity's valuations reduced by -24% on average for explorers and developers and by -26% for producers.

The Canadian firm specialises in small and micro-cap companies in Australia. When peers at UBS reviewed the sector last week, the average damage was a lot smaller as UBS restricts its research and coverage to larger-cap producers. But with no sustainable uptrend predicted for the price of bullion (not anytime soon), the underlying conclusion is pretty much the same:

"...tempered growth ambitions, continued operating and inflation headwinds combined with our reduced price deck means stocks are not as cheap as they look."

Make no mistake, amidst universal, broad-based sector weakness, there are always opportunities for investors, and both teams of sector analysts have their favourites, but the real message seems to be: rigid selection is key.

Not every share price that has fallen represents a great opportunity for mid- to longer-term investing. The challenge for investors is to identify the real gems and the real quality in a basket that is full of pretenders.

For what it's worth, UBS's favourites are Northern Star Resources ((NST)) among the large caps, because of the company's strong organic growth pipeline, and Gold Road Resources ((GOR)) among small caps. UBS analysts advise investors should focus on strong balance sheets, low risk growth and newer mines with a good runway and optionality still ahead.

Canaccord Genuity's sector favourites are Bellevue Gold ((BGL)), De Grey Mining ((DEG)) and Predictive Discovery ((PDI)). All three have rallied off their June-July low.

Macquarie's favourites are Northern Star, Silverlake Resources ((SLR)) and Gold Road Resources among producers, as well as Bellevue Gold and De Grey Mining among juniors in the sector.

Says Macquarie:

"Though sequentially softer gasoline prices should take some sting out of headline inflation, underlying inflationary pressures continue to broaden and momentum in core services prices does not yet show any sign of letting up."

As well as:

"We think it premature for the market to be anticipating a Fed pivot."

The latter suggests those 20%-plus share price moves for the likes of St Barbara ((SBM)), Bellevue Gold, Resolute Mining ((RSG)) and Regis Resources ((RRL)) might look premature once the market's focus changes back to on-the-ground dynamics and a likely persistence by the Fed to tame inflation with aggressive rate hikes.

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