Anglo American (AAL)
Return year to date: 289%
Commodities and mining stocks have seen massive gains in 2016. The coking coal price quadrupled, iron ore and thermal coal doubled in value, and copper is up 35% this year. However Morningstar equity analyst Mathew Hodge sees meaningful downside for commodity prices from current levels.
As China rebalances away from infrastructure and construction-led growth, long-lagging Anglo American will find itself better positioned than most diversified peers, said Hodge. The company has greater exposure to consumption-oriented commodities like platinum and diamonds, which should enjoy better demand growth than investment-oriented commodities like iron ore and copper that prospered most in the past decade. There Hodge believes that Anglo American is at a unique position among global miners with significant platinum and diamond exposure.
The company is rated as a one-star stock, meaning Morningstar analysts believe the stock is trading significantly above their fair estimate for the share price.
Glencore (GLEN)
Return year to date: 206%
Glencore is rated as a one-star overvalued stock by Morningstar analysts. The company ranks among the most diversified of the global megaminers. But because China is the key demand driver for nearly everything Glencore digs out of the ground, diversification benefits are limited, said David Wang, Morningstar equity analyst. With weaker Chinese demand growth set to pressure copper and coal prices, Wang believes profits will be far harder to come by than in years past.
BHP Billiton (BLT)
Return year to date: 75%
A geographically diversified customer base sees BHP Billiton tied to global economic growth, said Hodge. With demand for most products softening with the end of the China boom, BHP's earnings have been hit after peaking in fiscal 2011 at $22 billion. With the demise of the China-driven commodity boom, it's unlikely earnings will regain this peak, Hodge added.
Hodge said it is difficult to create and protect competitive advantages despite producing multiple commodities. BHP Billiton lacks real pricing power in its products. The excesses of the boom, coupled with lower commodity prices, have substantially diluted excess returns.
The stock is rated as a two-star stock by Morningstar analysts, meaning they consider it overvalued.
Fresnillo (FRES)
Return year to date: 67%
Fresnillo is engaged in the exploration, development, and production of gold and silver properties in Mexico. Fresnillo was among the best performers in the FTSE 100 in 2016 thanks to the ongoing rally of gold price throughout the year. The stock is not rated by Morningstar analysts.
Rio Tinto (RIO)
Return year to date: 65%
Rio Tinto remains overvalued according to Morningstar equity analysts, with the company particularly exposed to fluctuations in the iron ore price, which is likely to suffer as China transitions from investment-led to consumption-led economic growth. As a commodity producer, Hodge said Rio Tinto is a price taker, not a price maker. The lack of pricing power is aggravated by the volatile and cyclical nature of commodity prices.
Royal Dutch Shell (RDSB)
Return year to date: 61%
Shell is working to reduce its cost base, which has become bloated during the past five years, by reducing headcount and improving its supply chain, said Allen Good, senior equity analyst at Morningstar. Shell aims to reduce operating cost by 20% from 2014 levels by the end of 2016, with further reductions possible in later years.
Also Shell plans to dramatically reduce investment levels as new projects are completed by capping yearly capital spending at $30 billion through 2020. The sharp decrease should improve capital efficiency, but should not completely sacrifice growth, said Good. With a yield of nearly 7%, the market is already pricing in a dividend cut while overly discounting the impact of Shell’s improvement potential and benefits of the BG integration. The stock is rated as three-star by analysts, meaning they believe that the stock is trading at their fair estimate for the share price.
Morrison Supermarkets (MRW)
Return year to date: 58%
Morrisons’ profits decline in recent years will prove difficult to reverse, said Morningstar equity analyst Adam Kindreich. In the three years to January 2016, the company’s operating profit dropped by 65%, a decline of over £600 million. Management's own guidance for operating profit to benefit from a £50 million to £100 million boost from a combination of cost-saving and profit-enhancing initiatives looks decidedly unambitious, said Kindreich. Also Morrisons is not opening many new stores and is squeezed between the hard discounters and larger mainstream supermarket operators.
Kindreich predicts Morrisons will struggle to rebuild profitability and value destruction looks to be a more permanent feature of its business. The stock is rated two-star by analysts, meaning analysts think it is trading above their fair estimate for the share price.
Smiths Group (SMIN)
Return year to date: 57%
This stock is rated four-star by Morningstar analysts, meaning despite the rally in 2016 they believe the stock is trading below their fair estimate for the share price. Smiths Group is well positioned as a leading player in niche markets that manufacture products in security or safety sensitive industries.
More than half of Smiths' revenue comes from recurring revenue sources, enabling it to maintain operating profit margins well above 10%, even during troughs in the cycle, said Morningstar equity analyst Denise Molina. Molina also sees potential for improving returns in the next couple of years as global security screening is likely to see robust growth with demand for detection devices extending beyond traditional locations, such as airports and borders, to more general public venues.
BP (BP.)
Return year to date: 52%
The stock is rated three-star by Morningstar analysts, meaning analysts think it is fairly valued at the current share price.
BP reached a settlement with the U.S. federal government and Gulf States earlier in 2016, resulting in a reliable estimate of all its remaining Gulf of Mexico liabilities and eliminating the uncertainty about future obligations, said Good.
While BP will run a cash flow deficit through 2017, Morningstar analysts forecast it can cover a full cash dividend at $55 per barrel oil in 2018, one of the lowest levels among European integrates.
OPEC's announced production cuts in early December represent a positive near-term development for world oil markets, however improved near-team fundamentals come at a cost, said Good. Even a modest recovery in oil prices will incentivize U.S. shale producers to further ramp activity so that they eventually replace almost all "removed" OPEC barrels with their own. Increased near-term shale activity means that oil prices are unlikely to remain elevated for long, said Good.
Randgold Resources (RRS)
Return year to date: 49%
Similar to Fresnillo, gold miner Randgold Resources have been clear beneficiaries of the continuous rise in the gold price in 2016. However the price of gold has dropped over the last month as the dollar rose in value due to a hawkish US central bank statement early in December. The US central bank met market expectations by raising its target range for the Fed funds rate by 25 basis points to between 0.50% and 0.75%, leading to a drop of share price among gold miners.
