Commodities | Sep 10 2014
This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP
-Market undervalues growth, efficiencies
-Improvement in OECD consumption
-Potash demand growing
By Eva Brocklehurst
Citi believes metal and mining equities will range trade over the next three months, with a lack of positive macro data and earnings momentum. The broker is recommending buying the dips, with a view that commodity markets, particularly base metals and bulks, could surprise on the upside in the next year. Add to this the likelihood of increased cash returns.
The broker retains this view, despite the fact BHP Billiton ((BHP)) poured cold water over capital management hopes at its recent results. The broker suspects this is a timing rather than structural issue. Cutbacks in mining capital expenditure are improving the supply/demand balance and, together with higher returns and cash flow, this should underpin the larger diversified miners. Three key drivers for the sector include valuation, growth and operational efficiencies. The broker's analysis suggests growth and operational efficiency are undervalued by the market.
Value creation emanating from a reduction in capex and operating costs, and efficient deployment of capital, are positives that Citi suspects the market has been unwilling to pay for. The broker observes long-term returns are reverting to mean levels, but price/earnings multiples for the mining sector remain well below mid cycle levels. Still, with a backdrop of stable commodity prices, Citi expects the sector can re-rate in absolute terms as well as relative to the broader market. Increased pay-outs and buy-backs will be critical for lifting sentiment heading into 2015. In the short term earnings downgrades may persist, which could provide headwinds for any further re-rating.
Citi's China Economic Surprise Index, which measures data surprises relative to market expectations, has turned positive. This means data has been stronger than expected, although this benefit to the mining sector may have largely played out. Meanwhile, Citi's commodity-weighted global PMI index remains in positive territory and reflects improvement in the consumption of commodities in OECD countries. Citi notes volumes have been better than expected in the first half of 2014 but a levelling off in iron ore volumes is likely in the second half along with an acceleration of copper supply.
Port Hedland Port Authority has released August statistics, showing iron ore shipments increased to a record high of 37.4mt, up 3.7% month on month. Iron ore shipments to China were 32.0mt, up 4.8% month on month and up 43.9% year on year. The increase was driven by the ramp-up in BHP Billiton's Jimblebar operations and Fortescue Metals ((FMG)) also operating at "sprint" capacity.
Bell Potter notes iron ore prices have averaged US$94/t in the September quarter to date and the broker reduces FY15 iron ore price forecasts. The analysts now expect an average of US$95/t in the December half and US$105/t in the June 2015 half. The broker also observes the impact of price forecasts on earning estimates for producers under coverage means a lowering of the price target for BC Iron ((BCI)), to $3.40 from $3.60 and for Fortescue Metals, to $5.40 from $5.50. Earnings forecasts are reduced by 1% in FY15 and FY16 for both stocks.
Around 55mtpa of potash is produced globally, mainly for fertiliser production. Demand growth of 5% is forecast beyond 2020. Compelling factors include economic growth in Asia and Latin America, which rely on imports, and rising incomes in developing countries. Morgans notes the Asian middle classes are adding more meat and dairy to their diets, which in turn requires more planted acreage, more fertiliser and more animals to be fed.
At a time when access to mining finance remains restricted the opportunity in potash is skewed to developers with sources of new supply at the lowest cost. The broker has taken a look at Highfield Resources ((HFR)), an ASX-listed developer of three underground potash projects in northern Spain. Highfield's projects are shallow, close to power, water and labour inputs as well as markets. Moreover, capital intensity is about 50% lower than the company's peer average and this is a crucial differentiating factor for Highfield's flagship Muga project. A definitive feasibility study is expected at the end of the year. Morgans believes investors have a genuine opportunity in a company that is in transition to production from development.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.