Tuesday, July 28, 2009

Another Barron's Pan

In its "Weekday Trader" feature, written by Naureen S. Malik, Barron's has panned the Low P/E Bin stock BHP Billiton. The line of reasoning goes something like this: the prices of the commodities Billiton mines and sells have been shooting up lately. So has oil, which Billiton extracts too. They've been rallying on anticipation of returning growth in world demand, as well as China stockpiling, but the latter source of demand is temporary and the former isn't showing up yet. The last time metals had sustained rallies, there was real world growth and a real demand increase underpinning them. Now, there isn't; only expectations have shot them up. Consequently, given the high expectations, there's a real anticipation air pocket in those commodities and the stocks of companies who extract and sell them. If the recovery doesn't go as well or smoothly as the market's currently expecting, both metals and metals companies will fall - perhaps fall hard. There's no guarantee that will be so, but the risk/reward dyad has tilted towards low reward and high risk at these levels.

The argument makes sense, and Billiton has been on a real tear until recently. There's an additional cautionary factor relating to cyclicals in general: commodity, oil and cyclical stocks rarely show up in the Low P/E Bin when they're bottoming. [Peter Lynch made this point in One Up On Wall Street.] That's because the bottom is typically a time when earnings have turned into outright losses for those stocks. They tend to be hustled out of the Bin by then.

In a time like this, it may be a good long-term risk to take in a commodity Bin stock because reflation is clearly the order of the day. Except for the off chance that there'll be deflation this cycle, which the authorities may have overcompensated for, there's a good chance that a commodity stock currently in the Low P/E Bin will show a real long-term gain because the growth-inflation mix benefit industrial metals. Billiton's primary earnings generators are those kind of metals.

Actually, BHP Billiton is a bit of an oddity: had last year seen the top of a long-term commodity bull market, the Bin would have had lots of them. With the exception of Anglo-American, which has currently suspended its dividend, Billiton is the only mining stock in the Bin. On the other hand, oil and gas producers, including income funds and integrateds, outnumber the utilities. Had there not been a clear push towards reflation, I would be worried about that particular subsector.

Perhaps I'm being too easygoing. BP has reported a drop in earnings that's going to shove it out of the Bin. The stock sunk 2.61% in regular trading. [The company beat expectations, though.]

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