Commodity prices hikes caught the market off guard last year, piquing interest in resource sector stocks after they had spent years in the doldrums.
So expect a stellar performance from the miners when they turn in their profit reports.
AMP Capital expects a 5 per cent improvement in company profits this time around. But for the resources sector, this figure will be a healthy 16 per cent.
“It will be a strong reporting season in general,” Citi mining analyst Clarke Wilkins said. “There has been lots of earnings growth in the market, driven by mining stocks, purely from the pick-up in commodity prices.
“That’s to be expected because everyone can see what’s happened to iron ore and coal,” he added, noting that the strong recovery would be from a low base.
A hard look at iron
Iron ore is trading at US$80 a tonne now. This time last year, it was at US$47 a tonne. Coal is at US$84.06 a tonne. This time last year, it was at $50.71 a tonne. Wilkins said prices for the bulk commodities have probably peaked.
“Iron ore is the one to watch. Certainly the market has potential for more upside,” he noted.
Iron ore is the dominant driver for the sector and its price is the biggest guidance for earnings. It makes up a substantial proportion of the businesses of our three big miners – BHP Billiton, Rio Tinto and Fortescue Metals. So expect a strong performance when these businesses report.
BHP publishes its results on February 21 and Fortescue makes its announcement the following day. Rio Tinto has already reported.
Wilkins said copper was the interesting metal to watch. Potential strikes at the world’s biggest copper mine, Escondida, could help push prices higher.
This is a double-edged sword for Rio Tinto and BHP Billiton. They both have an interest in this asset and their revenue could suffer, should the strike happen. However, a strike would also potentially lower production of copper, causing its price to rise and benefiting Rio and BHP’s other copper assets.
There could be a benefit for listed Australian mining businesses that are not exposed to Escondida but do have an interest in copper, such as OZ Minerals. It’s not yet known how probable the strike is; the parties are negotiating.
For the rest of the year, Wilkins said, the question for investors is whether resource sector stock values have reached their nadir already because high commodity prices are already factored in. But he doesn’t think this is the case.
“So even though commodity prices have peaked and some have pulled back, shares have held up well in that environment because analysts had not factored higher commodity prices into their valuations for the big mining stocks,” he explained. “We are in a situation where there is still a mark-to-market upgrade for earnings for the sector, based on where spot prices are, so we’re still getting earnings revisions from resources sector stocks.”
Additionally, he said, cash flow from the miners is strong. But this has to be carefully managed.
“We’ve been in [a] situation before, where forecasts factor in strong cash flow but the money gets spent on acquisitions that are not value accretive.”
Alternatively, the miners have been known to use extra cash to increase capital expenditure, which leads to more production and downward pressure on commodity prices. And the cycle starts again.
But for now, the miners are in a sweet spot and should surprise on the upside this reporting season.
TOPICS: BHP Billiton, Escondida, Fortescue Metals Group, OZ Minerals, resources stocks, results, Rio Tinto