Mining valuations sky high as investors hope for recovery

Valuations in miners including BHP Billiton are trading at a 57 per cent premium to their long-term averages, Goldman Sachs says. Photo: BHP BillitonShares in mining companies have been summarily dumped by investors this year amid spiralling commodity prices, but their valuations remain sky high, suggesting investors are pricing in a recovery, Goldman Sachs says.

Mining stocks, including BHP Billiton have suffered huge falls amid a horror start to 2016. Shares in the Big Australian have fallen 18 per cent, spurred by a $US5 billion ($7.3 billion) write-down and the continued rout in commodity prices, notably oil, which has slumped more than 20 per cent in 2016.

But the price-to-earnings multiples for the mining sector are at a 57 per cent premium to its historical P/E – 22 times earnings versus 14 times earnings – thanks to a 70 per cent cut in forward earnings a  share as commodity prices continue to test multi-year lows, the investment bank’s head of portfolio strategy and quantitative research Matthew Ross says.

“That P/E multiples are high in the space implies that the average investor thinks that this will be a more cyclical downturn and there will be a recovery,” he said.

BHP Billiton has the highest valuation despite its shares hitting 11-year lows, trading at a P/E multiple of 27.3 times. Its five-year average is 13.1 times.

“We are still on the cautious side with resources stocks, we don’t see a strong catalyst from them to rebound.”

The valuation of the overall S&P/ASX 200 was fair, Mr Ross said. Trading at a forward price-to-earnings multiple of 14.2 times, it was just 2 per cent below its long-term average, meaning the market was a long way off distressed levels,

But the valuation dispersion – the difference between the cheapest and most expensive stocks – was at its widest since the global financial crisis, he said.

The most expensive stocks are trading at 26 times, while the cheapest sits at 8.5 times earnings. This was an ideal environment for value investors looking to pick up unloved but quality stocks, he said.

The banks and cyclical industrial stocks were the only pockets of the market trading at discounts to their long-term averages, but those discounts were modest and their earnings momentum was soft, he said.

According to Goldman Sachs research, the stocks with the most extreme valuations, those with the highest P/E ratios and trading the most above their five-year averages, include BHP Billiton, Blackmores, Domino’s Pizza Enterprises, API and Woodside Petroleum.

Those on the bottom end of the scale with the lowest P/E ratios include Sky Network, Origin Energy, WorleyParsons, Ansell and Computershare.

Mr Ross cautioned against buying into resources or resources exposed stocks that presented value, including Orica.

But there were others, including ANZ Banking Group, which was trading at a P/E of just 9.5 times compared with its five-year average of 11.3 times, signalling value at minimal risk.

However, if history was an indicator, the bad start to 2016 signalled more pain to come for the overall market. Mr Ross noted that only twice in the past four decades had the market had a similarly terrible start to the year: 1982 and 2008.

Both times the market went on to post hefty losses for the year. In 1982 the market fell 7.8 per cent in the first two weeks and fell another 12 per cent. In 2008 the index fell 9.3 per cent and went on to post a further 30 per cent fall.

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