Photographer: Martin Divisek/Bloomberg

UBS Analyst Who Called Mining Stock Slump Says Rout Not Over

  • David Cassidy tells investors to underweight resources in 2016
  • Favors firms benefitting from weaker Aussie dollar like CSL

David Cassidy, who correctly told investors to shun Australian mining stocks in 2015, says the worst is yet to come for the industry as China’s economy decelerates.

Investors should hold fewer commodity producers than are represented in the S&P/ASX 200 Index because shares are yet to bottom, says Cassidy, UBS Group AG’s head of equity strategy for Australia. Instead of speculating on some of the stock market’s worst performers, he’s telling investors to buy firms with profits that are closely tied to an upswing in the economy, such as developer LendLease Group and retailer Harvey Norman Holdings Ltd.

“We’re closer to the bottom but not yet willing to call the bottom here,” Cassidy said in a phone interview from Sydney on Dec. 14. “China is still likely to slow into 2016 while at the same time we are likely to see supply increases, particularly for iron ore. Slowing demand and increasing supply gives us a bearish setup.”

A 25 percent plunge by Australian materials shares has put the nation’s benchmark equity measure on course for its first annual decline since 2011. BHP Billiton Ltd. is trading near a decade-low and Rio Tinto Group is down 27 percent this year as analysts cut dividend forecasts and global peers from Anglo American Plc to Freeport-McMoRan Inc. shrink their businesses.

BHP has slumped 36 percent since Cassidy said in January that investors should hold an underweight position in mining stocks in 2015, citing downside risk to iron-ore price forecasts. He also accurately favored shares that earn revenue outside Australia, such as Aristocrat Leisure Ltd., and picked consumer staples to underperform. Still, not all of Cassidy’s calls were right -- he liked energy stocks, which have turned out to be the worst-performing industry group, and forecast the ASX 200 to finish the year at 5,700. It closed Wednesday at 5,028.40, 2.4 percent higher, led by a rally in energy shares.

All the 18 analysts tracked by Bloomberg with target prices on BHP expect gains from current levels, including Cassidy’s UBS colleague Glyn Lawcock, the firm’s mining analyst. He has buy recommendations on the stock and on Rio Tinto.

Cassidy said their views diverge because Lawcock’s ratings are based on commodity-price forecasts that in turn generate earnings estimates and long-term valuations.

“I have the licence to take a more tactical view on the risks around those commodity forecasts,” Cassidy said. “Most people’s medium to long term commodity prices forecasts are well above where spot prices are. So a lot of stocks will be coming up as buys, albeit the question is when do prices turn. From a strategy perspective you’re looking for catalysts, rather than just saying they’ll turn one day.”

Goldman View

Cassidy’s not the only skeptic, with Goldman Sachs Group Inc. also advising an underweight status on Australian resources shares. Rio Tinto and BHP are still vowing to pay higher dividends each year, a policy viewed by some analysts as unsustainable given the ups and downs of the industry.

“Valuations are closer to fair, but we worry about the value-destructive behavior that firms may engage in to maintain dividends in the face of collapsing earnings,” Matthew Ross, a Melbourne-based strategist at Goldman Sachs, wrote in a report Dec. 11.

UBS’s Cassidy now recommends companies with earnings closely tied to a pickup in economic growth, and those that benefit from a weaker Aussie dollar. He advises buying CSL Ltd., a maker of blood-based drugs and vaccines that gets 39 percent of sales in the U.S., and LendLease, a property manager. Harvey Norman, which sells everything from televisions to furniture, is up 14 percent this year.

Too Bearish

“Economic data has been printing quite reasonably compared to what the bears were expecting in recent weeks,” Cassidy said. “The market is too bearish on the economy.”

Australian employers added 71,400 jobs in November, confounding economist forecasts for a 10,000 decline. The report adds to impetus in housing construction and tourism as the nation’s economy moves on from a decade-long mining investment boom.

The Bloomberg Commodity Index tumbled 26 percent this year, on course for its biggest annual loss since 2008. Australian materials firms now comprise 12 percent of the S&P/ASX 200 index, the lowest proportion on record, data compiled by Bloomberg show. That compares with 4.3 percent of the MSCI World Index.

Investors “are looking for that holy grail of the bottom and when to invest,” said Cassidy. “It’s hard to say exactly when we’re going to reach that level but my concern is we’re not there yet."

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