Investments: Short-term caution does nothing to dim the long-term case for Rio

Nikhil Kumar
Tuesday 29 November 2011 01:00 GMT
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Rio Tinto

OUR VIEW: BUY

SHARE PRICE: 3,164P (+132P)

Rio Tinto is among the select group of companies that can reasonably be considered mining bellwethers. Alongside the likes of BHP Billiton, Brazil's Vale and a handful of others, it is a fully fledged commodities behemoth. It is, therefore, useful to pay attention to its comments on the goings-on in the resources world. And the latest noises have been less than bullish.

Speaking on Monday, Rio's chief executive, Tom Albanese, warned that "continuing stresses in the eurozone and a weaker outlook for the US economy are inevitably affecting customer sentiment, which has become more negative in recent months".

So, time to worry? Yes and no, in our view. Yes, the commodities market faces headwinds in the shape of the European debt crisis and the weak US economy. There is also the chance of some slowdown in China's heady rates of growth. But investors should note that these challenges will only add pressure in the short term (and possibly the medium term).

Long term, once the euro crisis has come to its conclusion and the global economy has recovered (and it will, in due course), the fact remains that the world is hungry for resources. And companies like Rio, who not only produce tonnes upon tonnes of prized industrial commodities today but are also investing to prepare for future demand, will reap the fruits of this appetite. There may be some short-term pressure on the share price but, further out, Rio remains well positioned.

Moreover, on the short-term picture, we were encouraged by the company's disclosure that it "continues to sell all it can produce". Customers may be cautious and commodity prices might fall back in coming months. But they will eventually turn north as hundreds of millions of people in places like India and China and elsewhere consume larger amounts of commodities. In the end, then, our rationale remains unchanged. We have been buyers of Rio Tinto because of the long-term trends. They remain intact.

Senior

OUR VIEW: BUY

SHARE PRICE: 164.8P (+2.8P)

Senior announced what we viewed as a pretty good deal yesterday. The industrial manufacturer said it had bought Weston, which produces machine parts and assemblies for the commercial aerospace market.

To put the deal into some context, it is worth remembering that the big aircraft manufacturers notched up some good orders at recent air shows. This bodes well for commercial aerospace building activity, which is what matters in this instance.

Weston is particularly exposed to Airbus, which is another big positive, as the European plane maker has recently booked some eye-catching orders (think of its success in luring customers with its expanded A320 family, for example). We therefore agree with Shore Capital's assessment that, while there may be no cost savings from the deal, the "acquisition is strategic".

Turning to the shares, Senior is trading higher than when we bought in earlier this year. But even then, it is hardly pricey, with the market valuing the stock at around 10 times forward earnings for next year. On enterprise value to earnings before interest, tax, depreciation and amortisation, it is on around 6.3 times, according to Shore. There is no reason to bank profits, as we think there is more to come.

Phoenix IT

OUR VIEW: HOLD

SHARE PRICE: 163P (-25.75P)

Phoenix IT appears to be a fair way from emerging from the flames, especially after yesterday's half-yearly results spooked investors and sent the shares tumbling by nearly 13 per cent last night.

Group revenues at the technology services firm declined from £148.4m in the six months to the end of September 2010, to £132.3m a year later. Pre-tax profits fell from £13.3m to £12.1m, which was in line with expectations among City analysts.

One problem for those watching the stock was the deteriorating debt position, as the net debt figure rose from £65m a year ago to £71.1m on 30 September. The company does expect working capital to improve in the second half, although it guided pre-tax profits lower during the period. But it was not just the debt position, but a disappointing order book, which was 11 per cent lower than a year earlier, that prompted the sharp, bruising sell-off in the Phoenix IT share price.

The Panmure Gordon analyst George O'Connor, while acknowledging that forecast downgrades and a fall in the shares were inevitable in light of the interims, said plans by the new chief executive, David Courtley, to restructure could spark a recovery in the longer term. However, he did acknowledge this was not a stock for "widows and orphans". No indeed, particularly in light of the conditions in the wider market. So, we would not buy, given the risk. That said, the prospect of a turnaround, and the thin valuation following yesterday's fall, means we would not sell either.

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