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Material Matters: Q2 Production Previews

Commodities | Jul 14 2020

Strong production rebound expected for diversified miners; E&P companies with strong fundamentals to lead the way; shifting dynamics led by the impending scrap imports ban in China

-A preview of the fourth-quarter results for metals, plus some stocks to consider
-Reporting season preview for Australian Exploration & Production companies
-China to ban scrap imports from 2021

By Angelique Thakur

June Quarter Preview for Metals

The Goldman Sachs commodities team is bullish on copper, aluminium and gold and recently upgraded 2021 price forecasts for the three commodities.

However, the team highlights a stronger Australian dollar will offset the gains from higher prices. Accordingly, earnings estimates for its mining universe have been lowered by about an average of -6% for 2020-21.

Irrespectively, the analysts maintain their belief the sector remains undervalued. From a multi-year perspective, Goldman Sachs favours copper, iron ore, met coal and zircon; all led by favourable demand-supply dynamics.

For the June quarter, Goldman Sachs expects diversified miners like BHP Group ((BHP)), Rio Tinto ((RIO)) and South32 ((S32)) to see a strong production rebound after a softer first quarter led by seasonal factors.

BHP Group’s FY21 guidance, expected to be released with the June quarter results, could be less than expected due to the continued impact of covid-19.

Fortescue Metals Group ((FMG)), OZ Minerals ((OZL)), Iluka Resources ((ILU)) and Champion Iron ((CIA)) are equally expected to have enjoyed a strong quarter driven by a combination of better production, less costs and rebounding sales.

JP Morgan also anticipates upside for OZ Minerals with the South American supply disruption continuing to act as a tailwind.

However, noting Iluka Resources had withdrawn its guidance, JP Morgan expects lower production with higher costs for the quarter.

On the other hand, mining stocks that are not expected to meet their FY20 guidance include Whitehaven Coal ((WHC)), Coronado Global Resources ((CRN)) and Alumina Ltd ((AWC)).

JP Morgan agrees with Goldman Sachs for Alumina Ltd, noting the alumina/aluminium markets will take time to recover but differs on Whitehaven Coal, expecting the company to meet its guidance.

For nickel, JP Morgan is Overweight on both IGO ((IGO)) and Western Areas ((WSA)) on account of growth prospects.

Among the large-caps, Goldman Sachs prefers BHP Group, Iluka Resources, South32 and Alumina Ltd.

BHP Group is preferred over Rio Tinto due to the former’s more attractive commodity mix coupled with better growth expectations and attractive margins.

Rio Tinto is downgraded to Neutral while Sandfire Resources ((SFR)) is demoted to Sell by Goldman Sachs.

In the mid-caps, New Hope Corp ((NHC)), Champion Iron and Coronado Global Resources are rated Buy by Goldman Sachs.

Companies with strong fundamentals to lead the way

Brent spot prices have increased quite a lot since April 2020 and while the forward curve still remains in contango (where the spot price is lower than the forward price), JP Morgan points out the spread between the longer-dated contracts and spot contracts has narrowed.

However, the broker highlights while higher short-term prices are beneficial for Australian producers, a stronger currency will offset the gains (similar to the miners above).

JP Morgan sees value in the sector, finding Cooper Energy ((COE)) to be the least expensive with Oil Search ((OSH)) considered most expensive at the other end of the spectrum.

Investors would do well to take a broad-based sector exposure, suggests JP Morgan, which would help them gain leverage to a recovery in oil prices while keeping them safe from individual company risks.

Going forward, JP Morgan analysts expect the Brent oil price to rise to US$45/bbl in 2021 from the current US$42/bbl.

This translates to an increase in 2021 forecast earnings by 16% in 2021, 8% above current market consensus.

Companies with strong balance sheets and fixed-price contracts are JP Morgan’s preferred picks with Santos ((STO)) and Beach Energy ((BPT)) its picks of the litter.

In the small-cap segment, JP Morgan likes Senex Energy ((SXY)) and Cooper Energy but is concerned about Carnarvon Petroleum’s ((CVN)) capital expenditure needs.

In general, LNG projects, with higher development risks and low prices, are best avoided, advises JP Morgan.

The reporting season is to kick off with Woodside Petroleum ((WPL)) the first in the sector to report on July 16, followed by Santos and Oil Search.

UBS notes Brent oil prices, if seen on a quarterly basis, were still down -29% in the June quarter. LNG prices fared worse, down -40% quarter on quarter and -64% year on year.

Given its exposure to spot prices, UBS expects Woodside to be impacted the most, though contract pricing may help soften the fall from the hit to Brent and LNG prices.

UBS highlights most of the Australian LNG contracts are based on the Japan Custom Cleared (JCC) price, which lags by three months, implying higher prices than seen in the March quarter.

In fact, contract prices are expected to be up 7% on a quarter-by-quarter basis and UBS anticipates the full impact of the price decline will only be reflected in the September quarter.

UBS expects updated guidance for 2020, expecting Woodside to focus on capex guidance and the Sangomar Phase 1 project.

Santos is expected to focus on cost guidance and update on the extension of its Bayu-Undan project life, now that a final investment decision on Barossa has been delayed.

For Oil Search, the update may focus on initiatives taken by the company to help it sustain a lower oil price environment.

China: Substituting metal scrap with alloys and ingots

China has been a global scrap trading hub for more than a decade but this is about to change with its Ministry of Environmental Protection announcing a complete ban on scrap imports from 2021.

The policy was first announced in 2017 as part of a plan to reduce waste pollution. Since then, incremental steps have been taken, including a ban on 24 types of solid wastes, restricting quota application to direct users only and assigning restricted quota for some metals, among other steps.

From January 2021, there will be a complete ban on Chinese imports of copper, aluminium and steel scrap with only high-quality renewable copper/aluminium alloys that meet certain standards to be allowed, reports Macquarie.

Copper scrap imports were once a key source for copper, contributing up to 14% of total available copper.

The scrap, imported from the US, Hong Kong and other developed countries, is divided into two categories – category 6 and category 7. While the import of category 7 scrap, containing more impurities, was banned in 2019, category 6 imports are set to be banned completely from 2021.

This has led to a shift in demand with imports of copper alloys/ingots increasing ahead of the ban. The focus is also shifting from developed markets as source countries to Southeast Asian nations.

Similarly, aluminium, scrap imports of which will also be banned in 2021, is seeing a shift towards importing alloys from Malaysia, South Korea and Indonesia.

Steel scrap has met a similar fate. Along with being the world’s largest steel producer and consumer, China also leads the world in steel scrap imports – now over 200mtpa in Fe-units.

But considering the steel scrap to be highly polluting, China’s Ministry of Environmental Protection introduced quota limits in July 2019, causing steel scrap imports to collapse.

Meanwhile, there has been an increase in the import of steel billets from Russia, Vietnam and India.

With intense lobbying to boost scrap supply, the ministry has agreed to reclassify high quality imported scrap as renewable resources in 2021.

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AWC BHP BPT CIA COE CRN CVN FMG IGO ILU NHC OSH OZL RIO S32 SFR STO SXY WHC WPL WSA