Demand for commodities from fossil fuels to precious metals and grains and livestock is not going away anytime soon as recent big acquisitions have shown. How can investors position themselves for the ride?
Big oil has always been associated with big money. In what was the second-largest mega deal of the oil industry in a fortnight, Chevron Corp on Oct 23 announced the acquisition of Hess Corp for US$53 billion ($72.34 billion), which holds a 30% own ership of more than 11 billion barrels of recoverable resources in Guyana in South America, seen as one of the world’s newest major oil producers. Less than a fortnight earlier, ExxonMobil announced it was paying US$58 billion for Pioneer Natural Resources, a front-runner in the US shale oil industry.
Both deals made it abundantly clear: For all the push towards renewable energy, the disapproving looks environmentalists give to non-electric cars and threats by bankers to withhold financing for exploration and drilling, oil remains a crucial fuel without which entire economies would grind to a juddering halt.
Analysts suggest more such deals might be in the works, ensuring a certain level of investors’ attention will remain on the broader com modities sector. “Chevron and ExxonMobil have both demonstrated confidence in a sector that is grappling with how to respond to the energy transition,” says David Clark, vice-president, corporate research for Wood Mackenzie.
“The scale of these two deals has certainly been a major step and a handful of other deals have prompted media buzz. We don’t think a flood of deals is a certainty but it is fair to presume that the parameters of C-suite discussions have been broadened by events of the last two weeks,’” Clark adds.
Closer to home, companies in what was supposedly the unsavoury business of producing fossil fuels like coal have gone ahead to double down on exactly what they know best — never mind the external pressure from sustainability proponents. Singapore-listed Indonesia-based coal miner Geo Energy Resources RE4 earlier this month completed the deal that will see it spend some US$200 million to take control of another Indonesian coal mine, which will significantly increase its output and reserves.
Multiple focus points
While this pivot should not undermine the call by environmentalists for sustainability and action against irreversible climate change, dropping the use of fossil fuel for other renewable energy sources entirely is a long-drawn transition.
When global energy demand outstripped supply during the pandemic and worsened by the war in Ukraine, investors who shunned fossil fuel producers soon realised the latter remained a lucrative business and that at times, sustainability efforts should be a secondary focus and considered just part of a whole. “Energy security, affordability and industrial competitiveness are now critical focus points alongside sustainability,” says McKinsey.
See also: Did Munger miss a trick by avoiding silver?
When war once again engulfed the Middle East earlier this month, energy prices were given a further boost. However, in recent days, oil prices have eased, lending confidence to some investors that geopolitical risks have been alleviated as Israel has yet to launch its ground invasion of Gaza as widely expected.
Vishnu Varathan of Mizuho Bank calls such optimism “premature, if not outright misguided”. The pullback in oil prices coincided with softer manufacturing data from Europe, he notes. “It must be recognised as contingent, calculated capitulation, not a durable bona fide calm,” says Varathan, the bank’s head of economics and strategy. “Live risks of a more uncontained conflict would be reflected in a heartbeat, “ he says, warning of a surge towards US$100 or even US$120 per barrel.
The MSCI ACWI Energy index, an indicator of the performance of some of the biggest companies in the global energy sector, is trading at 10 times earnings on a 12-month forward basis, says Mark Haefele, chief investment officer at UBS Global Wealth Management. This is a 35% discount to the broader benchmark and a 32% discount to history, supported by return on equity and free cash flow yield.
Haefele advises investors to take a closer look at energy stocks. “In a portfolio, we believe energy stocks can serve as a good hedge against both geopolitical and inflation risks. Higher oil prices are one factor that could lead inflation and interest rates to stay higher for longer,” he says.
Besides energy, demand for all manner of metals and minerals has remained buoyant in recent years. Although not exactly in a commodities “supercycle” foretold years ago, demand for key commodities such as gold has remained near records, with some bulls calling US$2,500 per ounce by the end of next year.
Energy and metals aside, prices of soft commodities or agricultural produce have generally come off their peak in the middle of last year although specific products such as cocoa are now at 44-year highs.
Sustainability spurs demand
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Ironically, even as economies become more digitalised and the sustainability movement gains greater traction, demand for commodities has increased, not decreased.
Digital economies of today consist largely of formless bits and bytes crisscrossing the world in transactions at lightspeed. However, plenty of materials like silicon, copper and rare earth metals are required to build billions of gadgets like smartphones, computers and mainframes while a lot more electricity is required to power the endless rack of data servers.
The push for wider adoption of electric vehicle has also increased demand for specific commodities such as lithium, nickel and cobalt, forcing miners to fight over the rights to extract them and giving companies in charge of processing them a lot more economic power. Meanwhile, at the more basic level, coal remains the most economically efficient fuel for many developing and developed economies.
In short, commodities remain an investible and invaluable asset class. Investors can get exposure to commodities in many ways too. Those interested in the iron ore market will be aware that the Singapore Exchange
In the investing universe, commodities can be broadly classified into four different types, namely agriculture, energy, livestock and metals. Examples of agricultural commodities include corn, rice, soybeans, sugar and wheat. Energy can be categorised into renewable and non-renewable energy. Solar, wind, and hydropower are examples of renewable energy while non-renewable energy includes crude oil, natural gas and nuclear energy. Livestock includes cattle, fish and timber while gold, silver and copper are examples of metallic commodities.
Offering portfolio diversification
Generally, prices of investible commodities tend to be more volatile than those of stocks and bonds as their demand and supply dynamics change quickly. However, due to its lower correlation with stocks and bonds, exposure to commodities can be a good diversifying tool in an investor’s arsenal.
The Edge Singapore has filtered a list of global commodity-themed stocks by categorising them into three main groups. These are metals, energy, and agriculture and livestock. Each group has a list of 30 selected stocks, which are scored based on analysis and a variety of financial metrics. These metrics consist of historical performance, profitability, yields & valuation, sentiment and financial safety. Based on the final score, each company will be given a valuation ranging from strongly overvalued to strongly undervalued.
The historical performance analysis looks at years of increasing revenue, positive profits and cash flow, and dividends paid. It also takes into account the consistency of performance. The profitability analysis considers operating margins, profit margins, cash flow margins, and return on assets and equity. Earnings and free cash flow yields, dividend yields, and price ratios such as price-to-book and price-to-cash-flow are areas considered in the yield and valuation analysis. The sentiment analysis looks at analyst ratings on the company and the consensus target price compared to the current trading price. Lastly, the financial safety analysis considers liquidity and solvency ratios, along with the capital structure of the balance sheet which includes retained earnings.
Table 1 tracks 30 metal stocks along with their valuations while Table 2 tracks 30 energy stocks and Table 3 tracks 30 agriculture and livestock stocks. Table 4 shows the top 15 highest-scoring companies, along with their business description.
From the tables, the two top companies for metals, energy and agriculture and livestock respectively are Fortescue Metals Group and Agnico Eagle Mines; China Shenhua Energy and CNOOC; and First Resources and Lerøy Seafood Group. The key business segments and risks will be discussed for each company.
Showing their mettle
According to our filter, Australian-listed Fortescue Metals, a US$42 billion market cap company, was the highest scorer in the metals category. Fortescue operates two main segments. The first is metals which cover the exploration, development, production, processing, sale and transportation of iron ore and the exploration for other minerals; and the other segment is energy which covers the development of green electricity, green hydrogen and green ammonia projects. The key risk of investing in the company is the volatility of iron ore prices, which will significantly impact the profitability of the company as iron mining is its main business. Higher expected capital spending, particularly in the energy business, could impact future profitability, margins and the attractive dividends Fortescue has been paying consistently.
Toronto-listed Agnico Eagle Mines is a US$25 billion market cap company that was the second-highest scorer in the metals category. Agnico segments its business according to the mines it operates and derives a significant portion of its revenue from gold. Silver, copper, zinc and other metals make up the rest of Agnico’s revenue and earnings. The key risk of the business is the volatility of gold prices, which will considerably affect the company’s profitability. Other business risks include production-related headwinds such as the mining of lower-grade gold and the depreciation of mines at a higher-than-expected rate. Inflation is also a key concern for the business, particularly in the jurisdictions in which Agnico operates, as the inflationary effect puts upward pressure on rising costs of labour and energy and disrupts global supply chains.
Feel the energy
Within the energy sector, Shanghai- and Hong Kong-listed China-Shenhua Energy, a US$80 billion market cap company, was the top scorer. China-Shenhua is primarily engaged in the production and sale of coal and the generation and sale of coal-based power to provincial and regional electric grid companies in China. The key risk of investing in the business is the volatility of coal prices, which affects its margins. The outlook for coal prices is also subject to potential downward pressures, mainly due to an increase in coal import volume and a slow rebound from the industrial and manufacturing sector. Also, given limited production capacity growth of the company, China-Shenhua would be more susceptible to pressure in coal prices.
Shanghai- and Hong Kong-listed CNOOC (China National Offshore Oil Corporation) with a US$85 billion market cap is the second-highest scorer in the energy category. CNOOC is the largest producer of offshore crude oil and natural gas in China and one of the largest independent oil and gas exploration and production companies in the world. The company mainly engages in exploration, development, production and sale of crude oil and natural gas. The key risk of investing in the company is the volatility of crude oil and natural gas prices which affects its profitability significantly. Another concern is macroeconomic risks such as deflation risk in China, which affects the supply and downstream demand for oil and gas. Further, the risk of industry policy changes such as allowing foreign participation in the oil and gas exploration and development business in China could impact CNOOC’s margins negatively.
Palm oil and oily fish
As for soft commodities, Singapore-listed First Resources EB5 , a US$1.7 billion market cap company, was the highest scorer in the agriculture and livestock category. First Resources operates two main segments. The first is plantations and palm oil mills that mainly involves the cultivation and maintenance of oil palm plantations and the operation of palm oil mills. The other segment is refinery and processing which markets and sells processed palm-based products produced from the refinery, fractionation and biodiesel plants, and other downstream processing facilities. The key risk of the business is the volatility of palm oil prices, which is the key factor in determining the company’s profitability. Also, the fruit yield is subject to the proportion of older trees and with older trees making up almost a quarter of First Resources’ total planted area, yield growth may be affected negatively.
Oslo-listed Lerøy Seafood, with a market cap of US$2.3 billion, was the other top scorer in the agriculture and livestock category. Lerøy’s main business involves the production of salmon and trout, the catching of whitefish, and the processing, product development, marketing, sale and distribution of seafood. One key risk of investing in the company is the volatility in the selling price of its catch, which can be affected by a change in supply through catch quotas and demand through consumer preferences. Another risk is sea lice, which adversely affect the business by reducing fish welfare and driving up production costs so sustained investments have to be made to address this issue, which affects short-term profitability.
Interested readers should note that the scoring tables illustrate the worth of a company from a quantitative standpoint. They ought to consider the qualitative aspects of a company in their financial analysis of potentially investable companies too.
Disclaimer: This article is for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy or sell stocks, including the stocks mentioned above. This article does not take into account the investor’s financial situation, investment objectives, investment horizon, risk profile, risk tolerance and preferences. Any personal investments should be done at the investor’s own discretion and/ or after consulting licensed investment professionals, at their own risk.
