City Natural Resources: Sentiment Negative, Valuations Below Average

City Natural Resources High Yield Trust (CYN) is focused exclusively on natural resources. The mining and natural resources sector has taken a pounding over the last two years, but valuations are now at the low end of their range and many companies are responding to investor pressure and prices by cutting capex. While still geared to the upside once prices improve, the managers have shifted CYN’s portfolio towards the dividend paying producers where they expect better returns in the medium term.

Investment strategy: Diversified resources exposure
CYN is a global fund that invests in equity and debt securities of companies in the mining and natural resources sectors and supporting industries. Two-thirds of the portfolio is currently in four sectors: oil and gas, gold, palm oil and uranium. It is managed using a mixture of top-down and bottom-up strategies and maintains a diversified portfolio of about 180 securities. Gearing (currently 21% net) is employed with a view to enhancing returns over the longer term with existing debt fixed at 3.5%.

Outlook: Sentiment negative, valuations below average
Reflecting concerns over the supply/demand balance in some areas, commodity and resource equities have experienced a difficult two and a half years. While the outlook is unclear with global growth forecasts still being trimmed, the question for investors is whether the market has become too pessimistic. Average P/B valuations for resource equities are close to the lower end of their long-term trading range (see Exhibit 2). The Datastream World General Mining Index is trading at a P/B ratio of 1.5x against a 10-year average of 2.6x. The manager believes that the best performing companies will be those that generate free cash flows and reward shareholders. The portfolio has therefore been shifted more towards those at the production end, with a focus on dividend payers. This has meant a reduction in mining company exposure, particularly gold, where the manager believes many companies are struggling to cover their costs at the current price, and an increase in holdings of oil and gas producers.

Valuation: Discount below longer-term averages
The current ex-income discount of 10.5% is below its three and five-year averages (14.1% and 16.5%) but above the average for the peer group (9.7%). In terms of short-term risk adjusted returns CYN’s one-year NAV Sharpe ratio is above the sector average (1.3 vs 0.9).

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