Super Miners Beaten But Not Broken

By David Dittman • April 19, 2013 • Pacific Digest

A deterioration global macroeconomic sentiment, the threat of weaker commodity prices, unfavorable weather, the impact of past management missteps and shakeups in top leadership have combined to act like kryptonite to global natural resource giants and AE Portfolio Aggressive Holdings BHP Billiton Ltd (ASX: BHP, NYSE: BHP) Rio Tinto Ltd (ASX: RIO, NYSE: RIO).

BHP’s share price has declined 15.36 percent on the Australian Securities Exchange (ASX) this year. Including dividends the stock has generated a negative total return of 14.03 percent through the close of trading Down Under on Apr. 19, 2013. In US dollar terms the price drop is 15.99 percent, the overall loss 14.67 percent.

The company’s American Depositary Receipt (ADR), which is listed on the New York Stock Exchange (NYSE) and represents two ASX-listed shares, is off 18.17 percent in price-only terms, with a total return of negative 16.91 percent.

Rio has generated a negative total return of 16.52 percent in 2013, on a 17.71 share-price decline on the ASX. In US dollar terms Rio’s ASX listing is off 17.1, 18.29 percent in price-only terms.

Rio’s NYSE-listed ADR, which represents one share of the company’s London Stock Exchange listing, is off 21.94 percent including dividends, 23.31 percent based on its price decline.

This still-kicking stock market rally has shown signs of wear of late, due at least in some part to China’s worse-than-expected 7.7 percent first-quarter gross domestic product (GDP) growth number. That’s combined with ongoing worries about US fiscal policy and turmoil in peripheral euro zone-weakling-du jour Cyprus to stir angst about demand and growth in a stagnant economy.

It must be noted, however, that this rally has always been flying in the face of underwhelming economic growth–even during the best periods of these post-Great Financial Crisis/Great Recession times. As history reveals, however, the stock market often moves independent of economic conditions.

According to the Reserve Bank of Australia’s Index of Commodity Prices for March, prices ticked up by 0.2 percent after a 2.6 percent gain in February. The largest contributors to last month’s increase were higher prices for iron ore and coking coal. The prices of rural commodities overall also increased, while the prices of crude oil and base metals declined.

But over the past year the index has declined by 7.5 percent, much of the slide due to softer prices for coking coal and thermal coal. Prices for iron ore, the key driver of profits for both BHP and, to an even greater extent, Rio, peaked at USD158.90 per ton  in February, up 80 percent from September 2012 near-term lows, but by March 14, 2013, had declined to USD144.10 per ton.

And metals and minerals data and research firm Roskill Information Services forecasts that prices will drop to below USD100, possibly south of USD90, as global output rises.

Meanwhile, the price of copper for May delivery, the most actively traded contract, was down 2.1 percent at USD3.137 per pound on Friday on the COMEX division of the New York Mercantile Exchange. The front-month April contract was down 1.8 percent to USD3.148.

A closing price below USD3.1828 for the May contract would satisfy the traditional definition of a bear market, as copper would at that point be 20 percent below its February 2012 high of USD3.9785. The red metal is often referred to as “Dr. Copper,” described as “the only metal with a PhD in economics,” because of its predictive quality vis-à-vis economic activity.

New projects due to generate first output in 2013 and shortly thereafter will put downward pressure on prices. Although levels forecast by Roskill point to an ominous future for BHP’s and Rio’s iron ore operations, these companies–with large-scale, low-cost projects–will be in good position to satisfy demand as smaller, less diversified miners struggle to make the economics work.

Base metals, including copper, account for approximately 19 percent of BHP’s earnings, while Rio’s Oyu Tolgoi copper-gold mine is one of its primary growth projects. But petroleum has surpassed base metals to rank second to iron ore for BHP, and iron ore makes up more than 80 percent of Rio’s profit.

BHP and Rio both combine sufficient diversification with unbeatable scale in packages that suggest they’ll be able to overcome short- and medium-term economic and commodity-price turbulence.

Adverse weather hurt BHP during the first quarter of 2013, as management reported a 5 percent sequential decline in iron ore output due mainly to a cyclone in the Pilbara region of Western Australia, though the result was in line with analysts’ estimates. Management also noted that Pilbara production and sales were running at approximately 177 metric tons per annum.

Petroleum volumes came in below the consensus forecast due to extended maintenance as well as cyclone interruptions. Copper production, however, was on target, as were aluminum and nickel output. Thermal coal, a relatively minor part of the earnings equation, disappointed.

Management reiterated output and sales guidance for BHP key divisions.

Rio reported a 7 percent decline in Pilbara iron ore production due to cyclones, as sales lagged 5 percent behind production due to port disruptions as well as a build-up of stocks ahead of expansion efforts.

Mined copper output fell 8 percent on a sequential basis, due mostly to a significant decline in grades from the Bingham Canyon mine in Utah. Escondida grades picked up, but mined copper output was flat overall, due to a lower contribution from ore stacked for leaching.

Management also reported weak alumina output due to a partial shutdown of a key asset and weather and weaker coking coal volumes compared to the fourth quarter of 2012.

Rio cut its 2013 production guidance by 125 kilotons of mined and 100 kilotons of refined copper to the wall slide at Bingham Canyon. This is roughly equivalent to a six-month outage, probably a better outcome than the market expected.

It’s hard to point to any clear catalyst that will energize BHP’s and Rio’s share prices. But long-term production growth is assured, their respective scale allows them to limit costs in ways other miners simply can’t match and their streamlining asset bases will remain chock-full of “tier-one” projects.

In addition, recognition by boards of directors at both behemoths of serious misallocations of capital resources in recent years has resulted in the appointment of new CEOs, as Andrew MacKenzie has replaced Marius Kloppers in charge of BHP and Sam Walsh is in for Tom Albanese at Rio.

Both new honchos have committed to more discipline when it comes to new projects as well as to finding cost savings at existing ones. The prospect of scaled-back capital expenditures holds out the potential for rising free cash flow, and that means dividend increases and/or share buybacks.

The Roundup

Here’s where to find discussion of earnings for AE Portfolio companies, most of which just reported fiscal 2013 first-half results. Some posted results for 2012, while others report on completely different schedules. We’ve included the next reporting dates for those companies. Please consult the Portfolio tables at www.AussieEdge.com for current advice.

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