Bloomberg News

Sprott Buys Energy With Commodities at Recession Valuation

October 24, 2011

(Updates today’s trading in 10th paragraph.)

Oct. 24 (Bloomberg) -- Chemical, metal and agricultural companies around the world have fallen to valuations whose only precedent came in the last recession.

Commodity producers in the MSCI All-Country World Index lost 17 percent since June 30 and traded for 10.6 times reported income as of Oct. 21, cheaper than 96 percent of days since 1995, data compiled by Bloomberg show. In Canada, where stocks get more value from producers of fuels and minerals than any other major developed market, losses in energy shares are exceeding oil prices for the first time in 17 years.

“It has everything to do with fear and little to do with actual fundamentals,” Sprott Inc.’s Eric Nuttall, whose Sprott Energy Fund is up 16 percent this month, said of oil stocks. “When people are in a fear-driven mode, fundamentals can be irrelevant in the short term. Eventually, the stock market will always be fundamentals-driven.”

Speculation that economic concerns have sent prices down too far spurred Nuttall, who oversees the C$116 million ($115.6 million) fund for billionaire Eric Sprott’s firm, to buy shares in Calgary-based Painted Pony Petroleum Ltd. and Trican Well Service Ltd. ING Investment Management’s Paul Zemsky says he’s waiting for a solution to Europe’s credit crisis and signs that China has stopped trying to curb inflation before buying.

Valuation Pressure

The S&P GSCI Index of 24 raw materials lost 12 percent last quarter, the biggest retreat since 2008. Copper fell 26 percent, crude oil retreated 17 percent and aluminum slumped 15 percent, according to data compiled by Bloomberg. Commodities are projected to rise in 2012. West Texas Intermediate crude oil may rise to $95 a barrel at the end of next year from $87.40 on Oct. 21, the median estimate of analysts surveyed by Bloomberg shows.

Declines that erased more than half the value from Luxembourg-based ArcelorMittal, Vedanta Resources Plc in London and Helsinki-based Stora Enso Oyj drove down the price-earnings ratio for materials stocks as much as 50 percent from the 2011 high, according to data compiled by Bloomberg. Before this year, the only time the shares were cheaper was during the 2008 credit crisis, data compiled by Bloomberg since 1995 show.

Mining and chemical companies in the U.S. are trading at 12.1 times analysts’ forecast profit for 2012, compared with 12.6 times for the full Standard & Poor’s 500 Index. Valuations fell even as analysts cut their 2011 earnings estimates by 3.7 percent since the start of September, according to data compiled by Bloomberg.

Debt Crisis

Investors sold shares as concern Europe’s debt crisis will spread dimmed prospects for economic growth. Gross domestic product in the U.S. may expand by 2 percent next year, down from an estimate of 3.3 percent in February, according to the median estimate in a survey of 82 economists by Bloomberg. Commodity stocks in the S&P 500 declined as much as 62 percent during the recession that began in December 2007, compared with 55 percent for the full index, data compiled by Bloomberg show.

“The huge amount of uncertainty is keeping the multiples low, but I’m of the camp that they’re just too low because I don’t think things are that bad,” Eric Green, a Philadelphia- based fund manager at Penn Capital Management, which oversees about $6 billion, said in a telephone interview on Oct. 19. “Things will work out better than the market is anticipating.”

Rescue Fund

The MSCI All-Country World Index rose 0.4 percent last week as investors awaited a summit where policy makers might increase the size of Europe’s financial-rescue fund to help Greece avoid a default. The S&P 500 advanced 1.1 percent to 1,238.25. The global stocks gauge climbed 1.8 percent today, while the S&P 500 increased 1.3 percent.

ArcelorMittal plunged 29 percent in August even after second-quarter earnings beat analyst projections and the world’s biggest steelmaker forecast higher shipments in the second half of 2011. BBMG Corp., a Beijing-based cement producer, retreated 41 percent between July 8 and Aug. 29, then slumped another 19 percent even after reporting a 45 percent increase in first-half net income.

While earnings for U.S. materials stocks rose more than profit for all S&P 500 companies in the past seven quarters, they’re so far underperforming the index for the three months ended in September. Since 2006, they have only fallen short of analyst forecasts once, in the fourth quarter of 2008. AK Steel Holding Corp. and Dow Chemical Co. are among the 19 materials companies in the S&P 500 to report earnings this week.

Alcoa Earnings

Alcoa Inc., the largest U.S. aluminum producer, posted profit that trailed analysts’ estimates on Oct. 11. European customers “dramatically” cut orders, hurting third-quarter results, the company said. Since the end of August, Alcoa has lost 17 percent, the third-biggest drop among S&P 500 materials producers, behind Cliffs Natural Resources Inc. and U.S. Steel Corp.

“You have a very uncertain direction of the economy now, and these things move around quite a lot,” Jason Brady, a managing director at Thornburg Investment Management Inc. who helps oversee about $73 billion from Santa Fe, New Mexico, said of materials companies. “The idea that commodity prices are going to go to the moon in a straight line isn’t really there anymore.”

The S&P/TSX Energy Index dropped 19 percent and West Texas Intermediate crude oil futures declined 17 percent in the third quarter, the first time in 17 years that the stocks had a bigger loss when both retreated. Companies are trailing because concern about the economy is masking the industry’s earnings potential, Michael Clare, a money manager at Creststreet Asset Management Ltd., said in an Oct. 17 telephone interview.

Recession Levels

“The oil equities are pricing in the potential for a recession and seem to be ignoring the oil price,” said Toronto- based Clare, whose firm’s energy hedge fund returned 137 percent from its inception in April 2005 through Sept. 30. “The oil price is telling you the oil market is quite a bit tighter than equity market investors would have you believe.”

The index of Canadian energy stocks has sunk 11 percent this year as concern about a potential recession has led investors to sell equities most-tied to economic growth. Suncor Energy Inc., the country’s biggest oil and gas producer, slumped 29 percent last quarter. Trican Well Service, an oilfield- services company that Sprott’s firm is buying, lost 34 percent last quarter. It has rebounded 21 percent this month.

Accelerating Acquisitions

Industry acquisitions are accelerating following the retreat. Kinder Morgan Inc. agreed last week to buy El Paso Corp. for $21.1 billion, the energy industry’s biggest transaction in more than a year. The deal creates the largest natural-gas pipeline network in the U.S.

Statoil ASA, Norway’s biggest oil company, said it plans to buy Brigham Exploration Co. for about $4.4 billion. New Gold Inc., which mines gold in California, Mexico and Australia, said last week it is buying Silver Quest Resources Ltd. and Geo Minerals Ltd. in an all-stock deal valued at C$121 million.

“The Chinese slowdown is exaggerated, the world continues to demand more oil and there will be a reacceleration in commodities prices as we move into 2012,” Tom Wirth, who helps manage $1.5 billion as senior investment officer for Chemung Canal Trust Co., in Elmira, New York, said in a telephone interview on Oct. 18. “These companies are in far better shape than they were in 2008.”

--With assistance from Stephen Kleege in New York. Editors: Chris Nagi, Nick Baker

To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net; Matt Walcoff in Toronto at mwalcoff1@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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