Wrestling with Resources

Wrestling with Resources

I noted with interest Anton Tagliaferro’s comments in today’s AFR, lamenting the apparent lack of shareholder focus shown by boards of directors in the resources and energy sectors. Reading these comments, it struck me that the boards of these companies are no doubt plagued by the same issues that confound value investors looking at these types of businesses.

As value investors, we aim to acquire an interest in a business when we can see that the value of the business is greater than the price we need to pay to own it. At Montgomery, we are concerned also with quality and a host of other factors, but let’s focus for the moment on value.

The challenge in valuing a resources business is that so much hinges on the price it receives for the relevant commodity. Without a reliable estimate of future prices, the uncertainty around valuation is very large, and it is hard to be comfortable that the business is worth more than the price needed to own it.

Commodity price forecasts, of course, are abundant. Every investment bank and stockbroker has a “price deck” which they closely monitor, and which guides their revenue projections for resources companies. Sadly however, these forecasts are generally of little use. History indicates that expert economic forecasters find a worthy adversary in the form of a dartboard.

So, if a value investor has difficulty in assessing the true worth of a resources company, what does a board of directors do when faced with the same uncertainty in contemplating a decision to invest large amounts of shareholders’ capital in a new growth project ? One suspects that the survival instinct kicks in. No one builds a “great” resources company by sending cash in the direction of shareholders.

MORE BY TimINVEST WITH MONTGOMERY

Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.