Material Matters: Coal & Iron Ore Miners

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A glance through the latest expert views and predictions about commodities: coal and iron ore miners

-Macquarie retains a positive view on coal miners as China attempts to restrict pricing
-Iron ore miner supply discipline underpinning the iron ore price
-Are Rio Tinto and Fortescue Metals oversold?
 

By Eva Brocklehurst

Coal Miners

Recently, thermal coal mining equities have rallied on what Macquarie believes is an increase in demand outside of China. Moreover, exports to China from Mongolia have reduced because of pandemic restrictions in the former.

China is now paying a premium for coal from the Americas (as its ban on Australian imports continues) and lower investment in coal globally has occurred as access to capital becomes more difficult. Low stockpiles in China have exacerbated the issue.

Macquarie strategists note reports stating China has started studying intervention measures in the coal market to restrict prices. The reported port price cap is RMB1,800/t or US$275/t, still well below current spot prices.

China has also attempted to boost domestic production to meet its supply deficit. As a result of this background, Macquarie maintains a positive view on coal miners which have free cash flow yields of more than 20% on its forecasts.

The broker expects a pullback in equities will occur as the benchmark price decreases, although there is still material upside to cash flow, earnings and valuation at US$150/t, -30% below current spot prices.

At US$150/t the broker's earnings forecasts for New Hope Coal ((NHC)) decrease by -10% in FY22 and increase by 100% and 650% in FY23 in FY24, respectively. For Whitehaven Coal ((WHC)) forecasts decrease by -15% in FY22 and increase by 155% and 900% for FY23 in FY24, respectively.

Coronado Global Resources ((CRN)) has only modest leverage to thermal coal and, at US$150/t earnings forecasts decline -5% for 2021 and increase 15% and 30% for 2022 and 2023, respectively.

Iron Ore Miners

Morgan Stanley observes supply discipline is supporting the iron ore price. The industry appears to have responded this way to China's deceleration of steel production in order to restrain a slide in the iron ore price.

This is most notable for Vale, for which sales have lagged its seasonally robust production numbers by -13mt. Depending on market conditions, the company has indicated it will continue to withhold lower-margin products from the market.

BHP Group ((BHP)) also had a relatively weak September quarter, as shipments were down -3% year-on-year, although the company pointed to major maintenance activities.

Meanwhile, Rio Tinto ((RIO)) has trimmed its 2021 shipment guidance. So, while strong steel margins in China have supported the iron ore price, the major companies' "value over volume" is also contributing to price strength.

In terms of product premiums, as steel mills continue to prefer higher quality the mix remains under pressure. The share of low-grade in Rio Tinto's product mix is rising and is now at 11% compared with 3% a year ago, Morgan Stanley assesses.

Both BHP and Rio have reiterated their production potential over the medium to longer term which the broker interprets as a defensive signal to prevent any new entrants from coming to the market.

While BHP has received a port licence to increase output to 330mtpa and will start debottlenecking, Morgan Stanley does not consider the ramp-up will be quick. Rio has also indicated that medium-term Pilbara capacity is 345-360mtpa which can be achieved after the new replacement mines are developed.

Morgan Stanley projects Rio will produce 350mt by 2024, contributing to meaningful surpluses in a market that will be ex growth by then.

As Chinese steel demand has eased, JPMorgan has downgraded iron ore price forecasts for 2021-23 by up to -16%. In the case of Rio, including the latest forward curves for base metals will help to offset some of the downgrade to iron ore.

Rio is also net cash and has dividend yields of over 10% assuming an 80% pay-out and the broker believes investors will be well rewarded owning the stock, particularly once sentiment on China's growth improves, which could occur after the Winter Olympics in February 2022.

While still envisaging the iron ore price has more downside to its trajectory, JPMorgan considers Rio and Fortescue Metals ((FMG)) oversold and recommends investors add positions on any weakness.

There may be near-term earnings pressure on Fortescue but the broker finds significant valuation support. There is uncertainty around the expenditure on Fortescue Future Industries as well as Iron Bridge and the widening of low-great discounts, but the broker believes the sell-off in the shares has more than accounted for this.

JPMorgan downgrades the valuation of Fortescue and Mineral Resources ((MIN)) by -7% and -9%, respectively. For Mineral Resources the outlook is more challenging, the broker acknowledges, as existing iron ore operations appear marginal in a lower price environment.

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