By Michael Tsang and Lynn Thomasson
Aug. 24 (Bloomberg) -- Commodity companies, the most- expensive stocks in the Standard & Poor’s 500 Index, are turning into relative bargains.
While investors are paying an average 33.1 times earnings this year for copper, plastic and seed producers, the premium drops to 17.7 based on 2010 analyst estimates that call for profits to almost double, data compiled by Bloomberg show. The decline in the price-earnings ratio is the steepest for any group in the S&P 500 and would leave the companies 23 percent less expensive than their historical average of 23.2 times.
To some of the world’s biggest hedge funds, that opportunity is too good to pass up, especially as brokerages boost forecasts following second-quarter profits that were 60 percent higher than estimates, the most of any industry. At a time when bears say China’s moves to rein in speculative investments may curb demand, Harbinger Capital Partners, D.E. Shaw & Co. and Marshall Wace LLP all bought commodity producers last quarter amid signs the global economy is emerging from its first recession since World War II.
“You tend to want to buy these stocks when the multiples are high and about to move lower,” said Leo Grohowski, who oversees $142 billion as the New York-based chief investment officer at BNY Mellon Wealth Management. “You’ve got these huge earnings swings coming up, and a lot of investors, like us, are looking ahead for a better 2010.”
115% Profit Surge
The firm has been buying more commodities and commodity stocks, including Phoenix-based Freeport-McMoRan Copper & Gold Inc., the world’s largest publicly traded copper producer, Grohowski said. Freeport will earn “between $5 and $6 a share next year,” or an increase of as much as 115 percent, he said.
Companies in the raw-materials industry have gained 67 percent from the S&P 500’s 12-year low of 676.53 on March 9, led by Memphis, Tennessee-based International Paper Co.’s 381 percent gain and Perrysburg, Ohio-based Owens-Illinois Inc.’s 259 percent increase. Only banks and brokerages have rallied more, rising 134 percent on average. The S&P 500 has advanced 52 percent in that period.
A gauge of raw-material shares led today’s advance in the MSCI World Index, as copper jumped by the daily limit in Shanghai and climbed 1.9 percent on the London Metal Exchange. The MSCI World Materials Index added 1.6 percent at 8:22 a.m. in London, while the MSCI World increased 0.6 percent. Futures on the S&P 500 rose 0.5 percent.
Contraction Stops
Analysts expect that the 29 commodity producers in the S&P 500 will earn an adjusted $10.26 per share in 2010, share- weighted data compiled by Bloomberg show. The 87 percent increase from this year’s estimate of $5.50 is the biggest of any S&P 500 industry. The shares would trade at bigger discounts than seven of the 10 industries that make up the S&P 500 even if earnings growth is half the rate forecast.
The Organization for Economic Cooperation and Development said last week the economies of its 30 members collectively stopped shrinking in the second quarter as Japan, France and Germany exited recessions. Renewed demand from China, the only economy among the world’s 10 largest that hasn’t shrunk in the last two years, helped end the contraction.
The price of copper has more than doubled from a four-year low in December, while aluminum and soybeans had each risen at least 24 percent from their lows through last week. The UBS Bloomberg Constant Maturity Commodity Index of more than 20 raw materials rebounded 49 percent since December after losing 55 percent of its value in the prior five months.
China’s Expansion
Shares of commodity producers are almost twice as expensive as those in the S&P 500, which trade at 17.2 times this year’s expected profit, and almost a third more than the next highest- priced industry, financial companies. Commodity producers in the MSCI World Index of 23 developed nations trade at 36.8 times earnings from the past year, the highest valuation versus the broader index since at least 1995, Bloomberg data show.
China’s economy, the world’s third-largest, may expand 8.7 percent this year and growth may accelerate to 9.8 percent next year, according to Citigroup Inc. in New York, which raised its 2010 forecast by 1 percentage point. The world’s most-populous nation is the biggest consumer of copper, aluminum, nickel, hogs, soybeans, vegetable oil and potash, and the second-biggest user of crude oil, data compiled by Bloomberg show.
‘Next Step’
“We’re on the cusp of an improvement in global demand,” said Ron Rimkus, a money manager for BB&T Asset Management. He helps oversee more than $15 billion in Raleigh, North Carolina, including shares of Freeport. “The first thing that happens is asset prices increase. The next step is demand will increase and we’re starting to see signs of that,” he said.
The discount for raw-material stocks relative to projected profits is justified because those earnings won’t materialize if metals retreat and demand from China slows, said Rafi Zaman, who helps oversee $22.5 billion as managing director of global equities at DuPont Capital Management in Wilmington, Delaware.
“The valuations are really, really overly optimistic relative to the earnings of these companies going forward,” he said. “China has a fair amount of these commodities already stocked up.”
Copper inventories monitored by the London Metal Exchange have climbed for six consecutive weeks, the longest span of increases since February. Scrap-copper imports tumbled 18 percent in May and 15 percent in June after rising for three months, government data show.
Yunnan Copper
New lending in China fell in July to less than a quarter of June’s level, as the government worked to avert speculation in stocks and property without choking off the nation’s economic growth. China consumes more than a third of the world’s aluminum output and a quarter of its copper production.
Yunnan Copper Industry Co., China’s third-biggest smelter of the metal, said last week that there were “no clear signs” of a recovery after the Kunming, Yunnan province-based company reported a first-half loss.
As China spends more of the 4 trillion yuan ($586 billion) announced last November for projects such as low-rent housing, infrastructure in rural areas, roads, railways, machinery and grain subsidies, commodity producers will benefit, said David Hussey, the London-based head of European equities at MFC Global Investment Management.
“China is going to continue to suck in materials,” said Hussey, whose parent company had $250 billion in assets under management as of June 30. “Infrastructure spending and all the projects that the Chinese government are putting in has at least a couple of years of very good growth to come.”
Freeport Estimates
Analysts’ 2010 earnings estimates for Freeport have increased by almost threefold this year, to $4.80 a share from $1.73 a share in January. That would be a 72 percent increase from this year’s consensus estimate, Bloomberg data show.
While Freeport is valued at 23.3 times analysts’ consensus estimates for 2009, close to the most expensive level since 2005, it sells for 13.6 times next year’s projected income. That’s 40 percent less than the median over the past 14 years.
Even if Freeport generates only half the earnings growth that analysts expect, the stock would still be valued below its historical median of 22.6 times earnings. Goldman Sachs Group Inc. recommended buying Freeport last week, saying China will drive global demand for copper that will result in a shortfall by 2011. The New York-based bank estimates Freeport’s profit will rise to $7.30 a share next year, a 162 percent increase from the 2009 consensus estimate of $2.79 compiled by Bloomberg.
Corn, Soybeans
Shares of Wilmington, Delaware-based DuPont Co., the third- largest U.S. chemicals maker, trade at 18.3 times this year’s estimated profit. Rising sales of its Pioneer brand corn and soybean seeds will help lift per-share income by 13 percent in 2010, analysts’ estimates compiled by Bloomberg show.
That implies a price-earnings ratio of 16.2 times, or 14 percent below the historical median based on data since 1990.
During the second quarter, 75 percent of commodity suppliers in the S&P 500 beat analysts’ estimates. Freeport’s results surpassed forecasts by 90 percent, while DuPont was bolstered by its agriculture unit, the world’s second-largest seedmaker behind St. Louis-based Monsanto Co.
Some of the biggest hedge funds have taken notice. Philip Falcone’s $7 billion Harbinger Capital Partners hedge-fund firm snapped up 1 million shares of Freeport in the second quarter, according to U.S. Securities and Exchange Commission filings compiled by Bloomberg.
The New York-based firm’s holding in Freeport was valued at about $50 million as of June 30, making it Falcone’s biggest new equity purchase during the quarter, the data show. The stock has since climbed 30 percent.
D.E. Shaw, Obama
Overall, the value of Harbinger’s shareholdings in material suppliers increased by 2.4 percent last quarter, the second- biggest jump behind the firm’s utilities holdings. Harbinger spokesman Charles Zehren declined to comment.
D.E. Shaw, the $29 billion hedge-fund firm founded by David Shaw, who advises President Barack Obama on science and technology, more than doubled his holdings in DuPont to 830,007 shares last quarter, while Marshall Wace, the London-based hedge-fund firm that oversees about $15 billion, established a 88,739 share position, regulatory filings show.
DuPont’s stock has climbed 28 percent this quarter.
Paul Welsh, a spokesman at D.E. Shaw, and Richard Farnsworth, a spokesman for Marshall Wace, declined to comment.
“There’s still more upside,” said Kevin Shacknofsky, who manages $2 billion for Alpine Mutual Funds in Purchase, New York. “You have the developed world emerging out of a recession and this huge Chinese demand. You could have a big supply-demand imbalance. The real demand will hit next year.”
To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net; Lynn Thomasson in New York at lthomasson@bloomberg.net.
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