Share tips: Natural resource firms likely to thrive in challenging year

Demand from emerging markets set to offset consumer slowdown in 2008
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The Independent Online

In putting together our portfolio for next year, we have taken the view that in the round 2008 will be another lacklustre year for share prices in mature Western economies. But we don't think there will be a recession, and are equally confident there won't be a crash. We don't entirely buy the "decoupling" theory, but remain bullish about emerging markets which we expect partially to offset the pronounced consumer slowdown likely to take place in the developed world.

For this reason, we think natural resource companies will continue to do well and have therefore included two of them in our portfolio for this year BP and BG Group. Both look undervalued in a sector where supply constraint continues to be the dominant underlying story. This should help provide support for the oil price at even at the present inflated levels as the world economy slows.

BG Group's offshore discoveries in Brazil provide the main excitement for the stock, but there is also the possibility of corporate action, with the Chinese having taken a significant stake in their determination to secure future energy supplies. Chinese interest in BP, whose stock also trades at a huge discount to the underlying value of its reserves, shouldn't altogether be discounted either.

Our other four FTSE 100 stocks are Standard Chartered, United Utilities, Daily Mail & General Trust, and Shire Standard Chartered again on the assumption that emerging markets will continue to prosper, and United Utilities on the basis that, now divested of its electricity supply interests, it will finally become a target for infrastructure funds. As one of the last quoted, pure water companies, it has scarcity value.

The credit crunch may undermine infrastructure valuations to some extent, but the sheer weight of money out there looking for a home makes UU as close as you are likely to get to a surefire takeover candidate.

We also think that once more settled conditions return to credit markets there is a chance of private equity taking another pop at Virgin Media, which is quoted on Nasdaq. The company is still being killed in the battle for subscribers with Sky, but in a quiet way under its acting CEO, Neil Berkett, seems finally to be doing at least some of the right things. The board remains as dysfunctional as ever, but the price of the shares is covered by the size of the tax losses and the cash alone, leaving the business in for nothing to the right buyer.

In the case of DMGT, we believe the stock is seriously oversold. For the time being, investment fashion dictates that anything to do with newspapers is dogmeat. In fact, DMGT has already diversified successfully into business to business and new media markets, and, even in a downturn, its uniquely powerful blend of national and regional titles is likely to remain strongly cash generative.

We are big fans of Shire, which has defensive and growth stock characteristics. Whatever happens to the economy, health care spending will continue to rise. Shire has an excellent array of niche products and has also wisely steered clear of mass-market medicines, which is where the main pricing pressures from generics are being felt.

Among our selection of smaller companies, we have included Proximagen Neurosciences, which attempts to identify and license therapeutics for neurodegenerative diseases such as Parkinson's and Alzheimer's. There is talk it could be a landmark year for the group.

Market observers have said the stock floated too soon, falling from a listing price of 154p in 2005, to as low as 87.5p last year. But it rebounded to finish 2007 on an 18-month high, even though it recently turned down a takeover bid.

Rumours abound of a lucrative buy-in and licensing deal. Widows and orphans steer clear.

International Ferro Metals is a solid bet in the commodities sector. Off 20 per cent from its mid-summer high, we think the stock undervalued with ferrochrome prices expected to continue near the current record high and full production set to resume at the end of this month when repairs on a pair of faulty furnaces are completed.

For another speculative gamble, you could try Phorm Inc, an AIM-listed developer of internet-based advertising solutions. Last summer, it raised $30m (15m) from investors at a big premium to the market price to help build relationships with leading ISPs. There has since been an eerie silence and the shares have bombed accordingly. Our understanding is that some of these deals are now close to being signed. For the time being, the company loses a lot more than it earns in revenues. Not for the faint-hearted.

We haven't included it in our portfolio, but for a throw of the dice you could do a lot worse than Northern Rock. The gamble is on a successful private-sector solution, but, even in the event of nationalisation, the company might be worth something.

With regard to The Independent's 2007 portfolio, our performance was decidedly pedestrian, though not entirely disastrous. Our top performer was Xansa, an IT outsourcing enterprise, which we tipped partly on the basis it was one of the first such UK businesses to invest heavily on infrastructure in India, giving it a competitive cost base, and partly on hopes it would be taken over. The latter of these two reasons proved well founded. In late July, the company was bid for at 130p a share by the French IT concern Groupe Steria, yielding a gain of 50 per cent on the price at the beginning of the year.

We were also right to pick a mining company, though our choice of Anglo American was perhaps the wrong one. Would that we had gone for Rio Tinto instead. Anglo we thought a good bet both on the continued boom in demand for metals from Asia and on prospects for consolidation. New management in the form of Cynthia Carroll as chief executive added a further attraction. As it has turned out, Anglo now seems more likely to be predator than prey. Even so, the stock showed a near- 20 per cent gain on the year.

Our confidence in James Murdoch's ability to turn BSkyB into an all-singing, all-dancing multi-media stock, offering broadband and telephony alongside pay TV, proved well founded. Packaging together the basic Sky product with broadband at a price which is less than the bulk of providers charge for just broadband has proved a winning formula, with Sky enjoying a virtuous circle of subscriber growth. The shares added more than 18 per cent.

Regrettably, this is where the good news stops. GlaxoSmithKline, PartyGaming and United Business Media all disappointed. As a betting business, Ladbrokes is expected to be hard hit by any consumer slowdown, and its shares have already suffered accordingly. Likewise Millennium & Copthorne suffered the double whammy of being in both the hotels and property business, two of the worst-hit sectors of the year.

But the real dogs were in the financials sector, where unfortunately we had two punts Royal Bank of Scotland and Experian. The latter of these turned out to be a bad bet for the very reasons we thought it would be a good one. We believed deteriorating credit conditions would increase the demand for the credit history data Experian provides. In fact it has done the reverse.

Royal Bank of Scotland was a surprising popular choice among newspaper pundits at this time last year. It looked cheap then, but that was before the credit crunch. One of the reasons for tipping the stock was that the chief executive, Sir Fred Goodwin, had supposedly forsaken his penchant for takeovers.

Half way through the year, he abandoned the chastity belt and entered the bidding for ABN Amro. Given what later occurred to the price of banking assets, he ended up seriously overpaying. Still, if the stock looked cheap a year ago, it looks even cheaper today. As with other stricken constituents of the 2007 portfolio, we expect a recovery of some sort over the next 12 months.

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