Money
Issue No. 34 - April/May 2007
On the Money
by Mr Marcus Campbell
On the whole, results from the first half reporting season were largely in line with previous periods, coming in slightly ahead of Goldman Sachs JBWere expectations.
The overall Earnings Per Share (EPS) forecasts for the Industrial equities have not changed significantly for 2007 and 2008. EPS forecasts for the Resources sector in 2006-07 have declined from +19% growth to +15%, while the 2007-08 estimates remain unchanged at around +9.0%.
Positive revisions were concentrated in service-based companies exposed to the growth segments of the economy — mining, Western Australia, financial services and employment.
Costs continued to remain a key issue, particularly for manufacturing companies and the Resources sector, Energy in particular.
Investors have clearly increased the multiple they are prepared to pay for future earnings, reflecting the strong liquidity in the market and the fact that earnings appeared to hold up well during the reporting season. These changes are best reflected in the prospective PE ratio for the Industrials (see Chart 1).
While there has been some reversal of these trends in the last few weeks, we continue to believe the ASX200 Industrials is expensive both in absolute terms and relative to the level of interest rates.
Valuation multiples are at levels which have proved unsustainable in the past. While the current high levels of merger and acquisition activity account for a portion of the valuation premium, at some point this theme will dissipate.
If, in the interim, long term interest rates have edged higher — a global risk for 2007 — and profit estimates for FY08 and FY09 have eased, the market will be vulnerable.
Identifying value in this market remains a challenge.
Diversified Resources continue to remain attractive, particularly in light of our positive view on commodity price...
