Share tip of the week: how to buy into the coming infrastructure boom

published 10 April 2009

Xstrata is the world's fifth-largest miner. Its earnings before interest, tax, depreciation and amortisation (EBITDA) come from extracting coal (43%), copper (33%), zinc (5%), nickel (8%) and alloys (11%). It owns a 24.9% stake in platinum producer Lonmin (worth around $850m), bought last summer. The big news for Xstrata came in February, with a controversial $5.9bn rights issue to cut its $16.3bn debt load. It also spent $2bn to buy the Prodeco thermal coal-field from its main shareholder Glencore.

Xstrata (LSE:XTA), tipped as a BUY by Deutsche Bank

Critics reckoned the deal smacked of providing a cheap loan for Glencore to take up its rights. But Xstrata still secured the much-needed funds. Sure, there are lingering concerns that it may have to return to the watering hole if the cash proves insufficient to avoid a breach in its banking covenants. Yet I suspect this outcome is remote because commodity prices are firming almost daily. Even if a fresh capital injection was needed, the board could potentially dispose of its Lonmin and/or Prodeca assets.

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More important is what's happening in the wider economy. After a period of collapsing demand after last year's sky-high prices, supply destruction is now centre stage. Global nickel production has dropped 20%, while output of zinc, coal and copper has dived 9%, 13% and 9% respectively. This could trigger a sharp snap-back in prices as the benefits from the $2trn or so of government stimulus packages begin to kick-in. A large proportion of this investment (eg, 70% for China) has been earmarked for metals-intensive infrastructure.

I would rate Xstrata on a through-cycle enterprise value (EV)/EBITDA of six. After deducting its proforma debt of $13bn, this generates an intrinsic worth of around 700p a share.

This is not a stock for the faint-hearted. The group is exposed to the very volatile metals and foreign-exchange markets and will probably not pay a dividend anytime soon. Plus there's always a chance that Glencore (34.5% stake) may become a distressed seller, triggering a large stock overhang. But with industry capacity being mothballed and commodity prices heading north, Xstrata looks a good long-term play on the industrialisation and urbanisation of emerging countries. The next trading statement is due on 5 May.

Recommendation: speculative BUY at £5.25

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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.