Material Matters: Oz Materials, Energy Stocks, Gold Mines, Oil, Aluminium And Alumina

This story features SANTOS LIMITED, and other companies. For more info SHARE ANALYSIS: STO

-Iron ore, coal sentiment poor
-Market factors in US$70.10/bbl oil
-Barrick’s Cowal mine up for sale
-Oil price trough still to come
-New aluminium supply uneconomic
-Alumina output ex China ramps up
 

By Eva Brocklehurst

Australian Materials

Investors remain concerned over demand prospects in China and thus the impact across the commodity complex, in Morgan Stanley’s observation. The broker recently visited investors in Asia and notes iron ore and coal sentiment remains poor, as a result of oversupplied markets and the relentless fall in steel prices. Morgan Stanley suspects the key driver of the deterioration in iron ore prices is demand in the steel intensive sectors in China.

There is some optimism regarding base metals, given more favourable supply side dynamics, but any demand surprise to the downside would overwhelm such support. Copper is the primary source of positive sentiment in this regard. Most investors were comfortable with the declining trend in gold while interest in uranium was notable, given favourable supply dynamics. Morgan Stanley expects sentiment on uranium to improve with the re-start of reactors in Japan.

Investors were concerned about the lack of a recovery in demand after the Chinese New Year. Despite numerous announcements and infrastructure project approvals there is little tangible evidence that suggests to Morgan Stanley activity is picking up. The risk of devaluation of the renminbi was also a key point for discussion, as most believe such a move would negatively affect demand for imported metals. Therefore, most investors are happy to stay on the bear side.

Energy Stocks

UBS has calculated the oil price required to justify the current share prices for each energy stock under coverage. The analysis suggests that, among the large caps, the market is factoring in an average oil price of US$70.10/bbl, with Santos ((STO)) continuing to factor in the lowest price (US$64.00/bbl). AWE ((AWE)) has the highest implied oil price at US$76/bbl, after it rallied 6.1% thanks to an impressive gas flow in the Senecio-3 well. The broker’s top pick remains Santos, which is trading at a 13% discount to its valuation using the forward oil curve. Among small caps the broker’s only Buy call is Karoon Gas ((KAR)), with the company drilling its very high impact Kangaroo West-1 well. UBS carries $1.60/share risked value for this well in its $4.50 target. Success could add up to $3/share to valuation but failure could wipe out the entire $1.60.

Gold Mines

As part of Barrick’s debt reduction process the company is divesting non-core assets, beginning with Cowal in eastern Australia and Porgera, in PNG. Over the past two years a number of Australian gold mines have been divested by offshore companies, namely Barrick’s Kanowna Belle, East Kundana JV stake and Plutonic as well as Newmont’s Jundee. UBS judges these mine sales have been well received by both corporates and investors.

In terms of quality, Cowal is envisaged to be one of the higher quality gold assets in Australia. The broker believes the mine could be worth around $650m. So which company would be interested? Independence Group ((IGO)), Evolution Mining ((EVN)), OceanaGold ((OGC)), Northern Star ((NST)) and Regis Resources ((RRL)) are all potential contenders. Based on balance sheet capacity and cash flow UBS believes Independence is the front runner. That said, with the low cost of capital, offshore competition could be strong.

Oil

Goldman Sachs suspects the main driver of a rally in commodity prices over recent weeks has been retail investor inflows into oil exchange-traded funds (ETFs), despite weak fundamentals. The broker expects well supplied markets and continued inventory build-up will underscore bearish forecasts for most commodities. Hence, the recent inflows into these oil ETFs are arriving too early and could reverse. The current environment continues to favour equities over commodities, in the broker’s view. These inflows are generating selling opportunities because they are at odds with the fundamentals. For oil, the broker believes the fundamental adjustment has some way to go and prices are yet to reach a trough. Later this year the trend should gradually reverse.

Aluminium

Commonwealth Bank analysts expect Chinese aluminium demand to grow 8.0% in 2015 and 7.5% in 2016, reflecting stronger consumption in the transport and electrical sectors. Xinjiang aluminium production should continue to lift through to 2020 as the province aims to lift new cheap capacity. Supply growth should remain broadly in line with consumption growth in China. Other major aluminium producers are expected to endure a weaker growth outlook, with the exception of India. From the analysts’ sample of new and uncommitted aluminium projects, all new supply looks uneconomical unless financial assistance is provided.

The analysts expect the deficit in the global aluminium market will ease in 2015 before moving to surplus in 2016. This underpins their forecasts for realised aluminium prices to fall 5% this year and a further 6% next year. Long run real aluminium prices are expected at around US90c/lb.

Alumina

The CBA analysts expect China’s alumina supply growth will slow to 1.0% this year from 6.0% in 2014, as rising output in some provinces offsets falling output in others. Alumina production costs are primarily driven by the quality of the bauxite, given the energy dispensed in converting bauxite to alumina. The analysts expect China’s plans to use domestic bauxite to boost alumina capacity will mean production costs remain relatively higher than elsewhere, because its bauxite ore has high silica content. China’s alumina deficit is expected to accelerate in 2015 before easing in 2016.

Strong supply growth is expected to come from India this year and, outside the major producers, Vietnam and Saudi Arabia are ready to ramp up alumina output. Prices are expected to strengthen by around 5.0% this year and rise marginally in 2016. Long run real alumina prices of US$335/t are expected by 2017. 
 

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