Macquarie Equities: more riches ahead for miners
12th January 2018
Resources Rising Stars
It’s been a great two years for mining companies, but don’t sell your shares just yet, reports The Australian.
That’s the gist of a report by Macquarie Equities that said the long “upgrade cycle” that began in early 2016 is set to continue in response to stronger-than-expected commodity prices.
Australian mining shares have been a standout in the past two years, with the S&P/ASX 200 Materials sector more than doubling since early 2016 while the market has risen about 25 per cent.
Whether or not the miners can keep outperforming depends on the outlook for commodities, mostly driven by changes in China’s demand for raw materials and the supply response from miners.
But with commodity prices still well above consensus estimates in most cases, Macquarie sees “material upside risk” to both its forecasts and consensus earnings averages, even with a pullback in Chinese demand as its leaders seek to curb polluting and inefficient capacity, and at the same time rebalance its economic growth towards a greater reliance on services sectors.
“Spot prices for most key commodities remain well above our forecasts and we believe the upgrade momentum could continue to drive outperformance versus the broader market,” the broker says.
It doesn’t think the miners will ramp up their supply plans so soon after the once-in-a-lifetime expansion that occurred in the last boom, though investors will no doubt be keeping a watchful eye on the capital expenditure plans of the major miners in the upcoming reporting season.
But while Rio Tinto and South32 are already widely expected to boost their cash returns in the profit reporting season next month, Macquarie says BHP Billiton could surprise on capital management.
With debt levels on target for Rio and BHP, it expects the majority of free cash flow generated to be returned to shareholders through increased dividends and share buybacks.
So there is “significant potential to increase capital returns” that should boost share prices.
Assuming gearing levels of 15 per cent for BHP and 10 per cent for Rio, and assuming South32 retains a minimum $US1 billion cash balance, BHP and Rio could return an extra $US5bn a year and $US3bn a year, respectively, in cash over the next two years under a spot price scenario while South32 could return $US1bn-$US2bn a year. The base case forecasts assume BHP, Rio and South32 are able to sustain dividends around 3 per cent a year, but it could be 6-8 per cent in a spot price scenario.
To illustrate the potential for further share price gains stemming from stronger-than-expected earnings and capital management if commodities stay where they are now, Macquarie says its “spot price scenario” delivers 25-35 per cent higher earnings for the diversified Australian miners in the current financial year, with earnings 66 per cent higher for BHP, 34 per cent for Rio and 43 per cent for South32.
Running the spot price scenario out to fiscal 2020 would give earnings 60-70 per cent higher for BHP and Rio and 70-100 per cent for South32 over the two years.
The broker has switched its preference to BHP over Rio — and kept an outperform rating on both of the biggest diversified miners — while leaving South32 with a neutral rating.
“Given the strength in current spot prices, the earnings upgrade momentum for all three stocks is strong, but highest for BHP over the next two years,” it said.
Fortescue Metals remains the preferred pick among the pure play bulk commodity miners, with the current share price factoring in realised prices below the spot price of iron ore.
Iluka is expected to secure additional mineral sand price rises this year, but that’s “more than factored in to the share price” and Macquarie kept its underperform rating there.
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