Cyclicals beckon as world economy looks healthier

New Zealand investors are beginning to turn their attention back to cyclical stocks, as business confidence from the September 11 attacks slowly recovers.

%Stocks such as Carter Holt Harvey are on %the rise as the market anticipates an upturn in the global economy over the next year, and therefore a rise in commodity prices.

"We've been seeing cyclicals performing very strongly relative to the defensive sector," said Macquarie Equities analyst Arthur Lim.

Cyclical stocks - forestry, media, meat and other companies heavily influenced by world prices - are more popular when the global economy is healthy.

Defensive stocks, such as banks, property and food companies, are seen as havens in times of trouble.

Mr Lim said the trend towards cyclicals had accelerated in the past month, even though "Enron-itis" had prompted a short-term flick-back to defensive.

Those fears, he said, might have been behind the stronger share prices of defensive stocks such as Contact Energy and Auckland Airport, stocks which implied stable earnings and whose balance sheets left little room for creative accounting.

Contact has bounced from $3.74 to $4.01 in the past two weeks, although brokers see it as a gradual recovery from Edison Mission's failed takeover offer.

Mr Lim said there was a poor understanding of what cyclical stocks were in New Zealand, because they did not fit into neat definitions. Carter Holt Harvey's pulp and paper business, for example, made it a "prime cyclical player" with global growth poised to begin in six to 12 months.

Fisher & Paykel Appliances, a "second-tier cyclical", was also well placed, with a "stronger operational base" after its split from the healthcare business and its inroads into the United States market.

Fletcher Building, Waste Management and other building sector associates were examples of domestic cyclicals, poised to benefit from the pending building boom. Fletcher Building hit $3.09 last month, its highest price since May 1999.

But Mr Lim put logging company Fletcher Forests in the "basket-case category" because of debt, a looming world wood glut, and log prices "at 30-year lows".

And meat and dairy firms, which are seeing prices come off their peak, did not make the cyclical category at all.

"The agri-business sector in New Zealand is not a cyclical player because the world economy has been going down for the last two years and we've had boom conditions in the agri-business sector."

Mr Lim said the belief New Zealand's rural boom was the result of a lagged effect of high commodity prices was wrong.

"It's a consequence of low currency ... There have been the lifting of subsidies from a range of agri-business products, there's the recovery of the drought in the South Island. Those are factors which have nothing to do with cyclicality."

Carter Holt Harvey, New Zealand's second-largest listed company, has caught the eye of other commentators. Salomon Smith Barney broker Craig Robins said institutions were generally underweight in such stocks, and Carters was the obvious contender.

"If the world is going to turn around, Carter Holt has a lot of leverage."

The company's share price has steadily lifted from $1.44 in November to $1.97. Trading volumes have been high over the past two weeks, gathering speed after the company posted a December quarter return at the top of analysts' predictions.

"Maybe after a long and difficult time in the doldrums, Carter Holt might be coming out of it," Forsyth Barr Frater Williams executive director Don Turkington said.

"Clearly, investors can see an improved performance in the stock, going forward."

But even though lumber prices are beginning to improve, the jury is out on whether Carter Holt and cyclical companies in general can achieve a recovery.

Forsyth Barr's head of research, Rob Mercer, believed that cyclicals had "already run quite hard".

"If 2003 does turn out to be a peak, the early cyclical stocks that have moved, like the building sector, are going to find it harder to keep the momentum of their performance going."

Individual commodity prices did not always follow the same trends, either. Forestry had remained quite subdued, and companies had to start adding value to counter the excess log supply and weak Japanese market.

Carter's earnings were improving, but it had to earn $150 million more during 2003 and 2004 than was forecast, he said.

That was management's aim, but "the long and short of it is, we're not running with the view that there's a lot of value upside in the likes of Carter Holt".

The key, Mr Mercer said, was finding cyclical stocks able to generate excess return on capital investments. Some were in industries where that was difficult. In cyclicals, "a lot of the things impacting on your business are outside your control".

Mr Lim said good management was what he looked for.

"The first level of profitability kicks in immediately when commodity prices improve. The second element of profitability comes about from them restructuring and improving the operational debt."

- NZPA