I’ve said it before, but most blue-chip stocks are overvalued. In fact, there wouldn’t be 20 stocks in the S&P/ASX 200 (ASX: XJO) (^AXJO) which I’d be happy to buy at current prices. Call me picky but I’d rather not lose money.
However, if I did go through and individually identify 20 potential buy ideas I’m guessing a majority of those would come from the resources industry. An industry which I have, until recently, been reluctant to venture into.
Although I’ve had my fair share of success stories in recent times (BC Iron Limited (ASX: BCI) and Liquefied Natural Gas Limited (ASX: LNG) spring to mind) it is high risk and determining what’s value and what’s not isn’t easy. That’s because when it comes to valuation, it’s a completely different kettle of fish.
Industrials like Telstra Corporation Ltd (ASX: TLS) or Woolworths Limited (ASX: WOW) have relatively predictable growth trends, enabling investors to value them with some degree of certainty. Resources stocks have limited or no control over their product pricing, putting their shares at the mercy of volatile commodity prices.
It’s all about supply and demand.
If you can fairly assess the likelihood of a commodity maintaining or increasing in value over the long-term, a well-run resources company with flexible balance sheets shouldn’t be overlooked. There are a number of opportunities in S&P/ASX All Ordinaries Index (ASX: XAO) (^AXAO) available right now. Here are five companies I have identified as either a buy, hold or sell.
If iron ore prices slump in the next two or three years, you don’t want to be caught holding onto shares of smaller mining companies which have large amounts of debt. Arrium Ltd (ASX: ARI) – formally OneSteel – is a company I’m bearish on. Although it says it has a cash cost (remembering cash costs excludes other important costs like royalties, administration, corporate etc.) of around $50 per tonne, the break-even cost is likely to be much higher. I’d rather buy a producer with lower costs and less than 33.8% gearing.
As you can see from the following graph, both BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) have outperformed the index’s 12-month return of 8.4% and nearly all of our favourite blue-chip stocks on offer like the banks and supermarket giants. However, BHP’s share price has moved into a range closer to fair value in recent months and perhaps isn’t the bargain it was six months ago. Nevertheless it’s still an exciting and reliable resources stock you should keep your eye on.
Conversely while it could be argued Rio’s share price has significant downside potential, I believe the current price reflects the uncertainty. However if you’re bullish on iron ore, one could also say it represents significant value at current prices.
Currently, I believe both Northern Star Resources Ltd (ASX: NST) and Senex Energy Ltd (ASX: SXY) are buys at current prices. Northern Star has the low cost and balance sheet flexibility to deal with further falls in the gold price whilst Senex is ramping up production of the world’s most sort after commodities: oil and gas. Both are reasonably priced and look set to reward shareholders in the next five years.