Share tip of the week: a play on the flight to the cities

published 20 March 2009

I've been warning investors not to get sucked into the dividend trap chasing high-yield stocks where the income is unsustainable. Many banks and home-builders have already cut payouts; I suspect tempting yields at BT and M&S are also vulnerable. As a rule of thumb in these credit-starved times, I would avoid firms that offer more than 7% returns, and have net debt greater than three times EBITDA.

Antofagasta (LSE:ANTO), rated OUTPERFORM by RBC Capital

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Sure, commodity stocks are risky. Early last year I advised investors to lighten their positions because sky-high prices could lead to demand destruction. Shortly afterwards copper dived 75%, falling from $4.0/lb in July to a low of $1.25/lb in December. But 18 months later, the pendulum is swinging the opposite way, with supply destruction now the order of the day. Lower prices mean higher-cost mines are falling like nine-pins with global production set to fall 9% this year.

With output tightening, copper has recovered to $1.6/lb. Industry think tank CESCO reckons it will remain firm for the rest of 2009. When confidence returns, there could be a sharp bounce in prices, particularly if this coincides with a restocking of inventory. This could happen sooner rather than later given the lift from the government stimulus packages being implemented around the world, along with China's aim to maintain GDP growth at 8%.

But until light appears at the end of the tunnel, it's critical for firms to stay profitable and have fully financed development plans. This is where Antagofasta's frugal cost base and solid funding stand out. For example, in 2009 it is scheduled to produce around 433,000 tons of the red metal at an average cash cost of $1.10/lb, 15% less than 2008. The story gets even better. Add by-product sales and this figure drops to $0.94/lb, meaning Antofagasta will remain in the black even during the worst downturn since the 1930s. I would rate Antofagasta on a multiple of seven times through-cycle operating profits (EBITA). After adjusting for the cash pile, that generates a fair value of around $11.9bn, or more than £8 a share.

Antofagasta may not be to everyone's taste. It is exposed to the volatile metals and foreign-exchange markets. Its assets are all based in Chile, raising geopolitical risk, and it is also 65% owned by the Luksic family, whose investment objectives may not always be aligned with minority shareholders. But with supply destruction now centre stage and commodity prices stabilising, Antofagasta looks a robust play on the long-term urbanisation of emerging nations.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.