Shares in those related to the natural resources industries — from miners and oil explorers, right through to infrastructure builders for these sectors — have endured a torrid time in recent weeks amid fresh fears over weakening commodity prices.
Despite their diversified operations across many sectors, mining goliaths Rio Tinto (LSE: RIO) (NYSE: RIO.US) and BHP Billiton (LSE: BLT) have not been immune to these concerns, and share prices have failed to gain traction despite a promising start of the year. Indeed, Rio Tinto has shed almost 5% during the past month alone while its industry peer has haemorrhaged around 17%.
Prices primed for a sharp comedown?
And I believe that both stocks could be set to experience more pressure as economic data keeps on disappointing and earnings forecasts subsequently come under scrutiny. At current prices BHP Billiton changes hands on a P/E multiple of 14.8 times predicted earnings, based on current projections of 141.8 US cents per share. And its rival trades on an even higher ratio of 16.4 times, prompted by earnings expectations of 265.7 cents.
I believe that both companies should be trading closer to 10 times forecast earnings, a reading symptomatic of firms carrying huge risks for investor returns.
Indeed, with macroeconomic newsflow and industry continuing to disappoint, I reckon a sharp price correction could be on the cards to drag the earth movers closer to these levels. Such a scenario would see Rio Tinto concede a whopping 40%, from current prices of 2,877p per share to 1,734p, while BHP Billiton would fall 31% from 1,340p per share to just 925p.
Cast-iron correction on the cards?
The mining sector remains beset by fears of galloping oversupply in all major markets, none more so than in the iron ore sector where all of the world’s major suppliers remain committed to aggressively ramping up production. Rio Tinto saw earnings from this critical market collapse 18% in 2014, while BHP Billiton noted a 35% dip during July-December from the prior year.
Low-cost operators remain committed to putting their smaller industry rivals out of business by increasing output, although such a programme threatens to keep the market swamped for years to come. Indeed, this week UBS reiterated its forecast for iron ore prices to shuttle back towards their multi-year lows around $48 per tonne during the second half of the year.
And a steady stream of disappointing data from resources glutton China is compounding market fears over worsening commodity market balances. Latest manufacturing PMI showed factory floor activity contract for the third consecutive month in May, at 49.2, with stimulus measures from the People’s Bank of China failing to boost the cooling economy.
Against this backcloth it is difficult to see how the likes of Rio Tinto and BHP Billiton will stem the tide of significant earnings weakness any time soon. Consequently I reckon both companies, like many across the sector, are in severe danger of a vast share price fall.