Mining prices hold up well for Xstrata

Sep 7 2009 by Andrew Miller , The Journal

DESPITE the strong rise in commodity prices since March, we are maintaining our bullish stance on mining fundamentals.

Clearer signs of demand growth especially from emerging economies, slow restart of idle capacity, persisting long-term supply constraints and high barriers to entry should continue to underpin prices in our view.

With a relatively high cost base compared with some other diversified miners, Xstrata offers a higher operational leverage to rising commodities.

The company also benefits from a very good competitive position in coal and copper in particular, with an attractive geographical diversification and successful operational track record.

M&A is also likely to be an important part of Xstrata growth strategy.

The proposed merger of equals with Anglo American would generate significant synergies in our view, but should it fail to go through, other value-creating acquisitions could be on the cards.

Our fair value of 1,150p, based on a 2010 PE of 13.0x, shows nearly 40% upside to the current share price.

We are upgrading Xstrata to buy from neutral.

Rio Tinto – The announced disposal of the majority of the Alcan packaging business and the H1 results are signs of Rio’s improving financial strength.

The recovery in commodities markets, further asset sales and future growth capex should underpin profits growth and balance sheet stability.

The implementation of the joint venture with BHP in Western Australia next year should also create significant synergies.

We expect the shares to re-rate accordingly.

WPP Group – WPP reported a further decline in revenue and lower margins at its interim results, but Q2 looks to be the low point in the cycle, with the company pointing to an improvement in H2 and flat revenue for 2010.

WPP signalled it would be comfortable with a credit downgrade and this gives some backing to the current level of dividend and reduces the need for a rights issue.

We continue to like the advertising agency sector, believing it will outperform in a market recovery.

On its current low rating, WPP is one of the cheapest ways of gaining exposure to the sector.

AXA – AXA’s shares have continued to rebound from very low levels around the time of the last results, where there were concerns of an imminent rights issue.

Bar robust interims, there has been little company news flow, which in itself has alleviated concerns.

The company’s solvency position remains solid, and we think that concerns over the US variable annuity hedging are overplayed; in fact, the group has only booked a profit here so far.

The valuation can seem a little rich, at 1.4 times embedded value, but for this we expect superior growth and risk management.

Andrew Miller is regional head of Barclays Wealth