Why mining stocks can keep climbing

29th March 2019
Resources Rising Stars

Australia's big miners have rallied hard, but that hasn't stopped Credit Suisse moving overweight (reports The Australian Financial Review).

Australian mining giants might have had a stellar run over the past 12 months, but Credit Suisse’s head of global equities, Andrew Garthwaite, believes they’ve got scope to push higher still on the back of some big global trends.

Credit Suisse moved overweight on the mining sector earlier this week, after seeing signs that the slump in global industrial production in the final quarter of 2018 was starting to bottom out.

Garthwaite points specifically to the small rise in the new orders component of the global Purchasing Managers Index, and particularly the February rise in new orders component of China’s official National Bureaus of Statistics PMI index. The new orders index rose 1 percentage point to 50.6 per cent.

“Historically, mining has outperformed one to three months after China PMI has moved up,” Garthwaite told Chanticleer on the sidelines of the Credit Suisse Asian Investment Conference in Hong Kong.

“(And) if global industrial production rises, historically that’s obviously good for commodity prices.”

But one other slightly surprising historical marker that Garthwaite points to is the inversion of the US yield curve, which occurred briefly this week. While inversion has been a frighteningly accurate predictor of a recession, it hasn’t been unkind to mining.

“Historically, mining has outperformed 80 per cent of the time the yield curve has inverted,” the London-based Garthwaite says.

Credit Suisse is also attracted by the fundamentals of a sector that has cleaned up its act markedly in the past five years, slashing costs, paying down debt and focusing maniacally on generating cash flow.

Indeed, on spot commodity prices, Credit Suisse says the sector’s free cash yield is around 11 per cent. Even when stress-testing free cashflow by adjusting to the capital expenditure the miners need to maintain their operations, the yield is still between 4 per cent and 5 per cent.

“That’s a pretty good outcome, and on delevered balance sheets,” Garthwaite says, adding that only the technology sector has got a better overall balance sheet.

Credit Suisse also likes the renewed focus on shareholders being demonstrated by the miners. Rio Tinto (which is up 26 per cent in the past 12 months) has lavished its investors with $18 billion in dividends in the past year, while BHP (up 30 per cent) has also returned tens of billions of dollars. The payouts are likely to continue while commodity prices remain elevated.

“If you look at dividends as a proportion of capex, it’s never been higher,” Garthwaite says.

He also argues that it’s “hard to see disruption disrupting too much mining demand”. Where many other sectors face profit pressures from technological disruption, mining could actually benefit as, for example, new technological developments push up demand for materials such as copper.

The structure of the sector also appeals to Garthwaite, who says what he calls the “quoted cartel” in iron ore – where BHP, Rio, Fortescue Metals Group and Brazil’s Vale dominate supply – provides an extra level of insulation.

“If something went completely wrong and there’s a global downturn, well actually the quoted iron ore producers are going to be around, it’s the unquoted guys that are going to have a problem.”

Garthwaite’s concerns about the United States Federal Reserve being willing to accept allow the US economy to run hotter and accept more inflation – something that has been made clear by the appearances of three current and former Fed bigwigs at the conference earlier this week – ironically support his mining call.

“If the Fed is going to go soft on inflation, people are going to want to buy real assets,” he says.

“If you can take the macro out of mining, I am always biased to companies that are focused on the shareholder, that are delevered, have long asset life, are not suffering from disruption (and) are in quoted cartels.”

If there’s a risk to this rosy outlook, it’s that China focuses any fiscal stimulus on the consumer sector, rather than pumping money into capital investment, which naturally needs commodities.

In this case, Credit Suisse is most keen on exposure to aluminium, which Garthwaite is more leveraged to the consumer sector.

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