Positioning for a recovery
By Lee Wen Ching, OCBC Research
Commodities-related shares have staged a strong rally in recent weeks, driven by hopes of resurgence in demand, as measures taken by US policy-makers spurred optimism that a global economic recovery could be in sight. Commodities stocks surged by an average of 18% during the month of March, outperforming the Straits Times Index's (STI) 11% return. In particular, Olam International (Olam) outperformed its peers with an impressive 27% gain.
The haze has yet to clear.
In our view, it could be premature to call a bottom at this juncture. Economic indicators remain mixed – while inflation has been tapering off and commodity prices have somewhat stabilized, weakness in global trade persists, credit markets are still in the process of thawing and growing unemployment could continue to weigh on demand.
A sustainable improvement in demand and supply fundamentals must be backed by a convincing recovery of the real economy, which we have yet to see. In the near term, potential earnings disappointment could create more downside risk.
Olam & Noble
Among the realm of commodities-related companies, Olam will continue to gain favour in the near term for its resilient earnings growth profile amid an environment of earnings contraction.
However, in the medium term, Noble is better poised to reap the benefits of economic recovery. Our view stems from their respective product portfolios – Olam deals solely in agricultural commodities (mainly food, for which demand is relatively inelastic), whereas Noble's portfolio encompasses a broader spectrum of commodities spanning agriculture, energy, metals, minerals and ores. Metals and energy expose the group's earnings to more cyclical volatility, but also enable the group to participate in governments' pump-priming initiatives.
We are anticipating positive earnings growth from Olam and Straits Asia Resources Ltd (SAR) and negative growth from Noble for 1Q CY09. Nevertheless, Noble remains our top pick in the sector as it will be the key beneficiary of macroeconomic recovery.
In addition, Noble enjoys the healthiest balance sheet and is trading at a substantial discount to Olam. We retain our BUY ratings on Noble (fair value S$1.33) and Straits Asia Resources (fair value S$1.15). We are downgrading Olam to HOLD on valuation grounds given the recent run-up, but raising our fair value estimate to S$1.51 (from S$1.37). Catalysts for the sector include: (i) economic recovery, (ii) improvement in credit markets, and (iii) pump-priming initiatives.
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