Why resource stocks can outperform in second half
Australian financial shares are priced at a 37 per cent premium to global competitors, according to recent data by Worldscape and Datastream, while our resource companies trade at more than a 50 per cent discount.
However, resource firms are well positioned move back into vogue as fears over domestic and global inflation reverberate through financial markets through the second half of 2021.
The share prices of our miners are leveraged to price increases of their resources in the ground.Credit:Bloomberg
So far this year, resource stocks have lagged broader market gains. However, from here, they could benefit from any signs of rising inflation because their share prices are highly leveraged to the price increases of their biggest assets â€" metal and other resources in the ground.
We all know the financial sector’s importance to the Australian economy, with the big-four banks commanding almost 40 per cent, by capitalisation, of our sharemarket.
However, can this dominance continue? Let’s look at a hypothetical.
Consider the Australian financial sector as a single company: let’s call it Bank Australia.
Now, let’s compare the investment prospects of Bank Australia against all large company investments worldwide.
First, let’s look at the valuation of Bank Australia, using a broad-based value measure â€" book value, sales, earnings and dividends.
Out of 12,295 large companies at the end of May, 2021, Bank Australia would be cheaper than 6,518 of them. That is cheaper than 50.4 per cent of the worldwide company universe. It would also be more profitable than 6,873, or 53.2 per cent, of these companies based on Return on Equity.
We all like cheaper, more-profitable companies. So, if we add the two percentiles â€" the per cent of companies that Bank Australia is cheaper than and the per cent of companies that it is more profitable than â€" we can get a good measure of its investment attractiveness.
Bank Australia has a score of 103.6 per cent. The higher the score, the cheaper and more profitable the company, so Bank Australia’s score is not bad. The average company worldwide would score 100 per cent â€" 50 per cent for value and 50 per cent for profitability.
So, how does Bank Australia stack up against offshore financial companies?
The hypothetical Bank US comes in at 114 per cent, Bank Europe at 118 per cent and Bank Emerging Markets at 121 per cent. Our financial sector is unique and, as a result, we could argue that it deserves to trade at a premium. But a 37 per cent price premium to our offshore rivals?
With Bank Australia already trading at elevated levels, it is unlikely to drive the Australian sharemarket higher in the short term. But where will the growth come from?
Let’s do the same calculation for the Australian resources sector. The hypothetical Mine Australia would represent a quarter of our sharemarket.
Our mega-mining company would be cheaper than 54 per cent of global rivals and more profitable than 63.4 per cent â€" far better than Bank Australia’s score.
As we did for Bank Australia, adding these two scores together for Mine Australia tallies to a whopping 117.4 per cent â€" well above the average of 100 per cent for the worldwide resources company universe.
Also, importantly, the score is well above the average for offshore mining companies. The score for hypothetical Mine US is 97 per cent, Mine Europe’s is 101 per cent and Mine Emerging Market’s is 113 per cent.
Because our financial firms are expensive on a global basis and our miners cheap, we would expect that resource companies are more likely to drive our market higher in the second half of 2021.
Mike Aked is director of research for Australia at Research Affiliates
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