02-05-18

BUSINESS A.M. FEBRUARY, MONDAY 05 - SUNDAY 11, 2018
COMMODITIES & AGRICULTURE
31
Miners, investors bet, fret over
latest commodities cycle
A
combination of accelerating global
growth and supply constraints has
driven raw materials — as measured
by the Bloomberg Commodity Index
— to their highest level in more than
three years, boosting the profitability and cash
positions of the world’s biggest mining houses.
As a result, the sector is enjoying its best
run since 2010 as investors look forward to
bumper payouts. Morgan Stanley estimates the
industry generated $23 billion of excess cash
last year and will generate a further $21 billion
in 2018, if current commodity prices hold.
That should give delegates plenty to celebrate
at the meetings, private dinners and
cocktail receptions that are an integral part of
Investing in African Mining Indaba.
But after two consecutive years of gains —
the FTSE 350 mining index, which counts Anglo
American, BHP Billiton, Glencore and Rio
Tinto as constituents has surged 186 per cent
since 2016 — the question those at Indaba will
be asking is, can the party continue?
For many the answer is yes, as long as the industry
maintains shareholder friendly policies
that place profits and dividends above megamergers
or building expensive new mines,
and demand in China — the world’s biggest
consumer of commodities — holds up.
“Valuations are low, balance sheets are
strong, and fundamentals are positive. This is
the sweet spot of the cycle, and mining shares
should outperform again in 2018,” says Christopher
LaFemina, analyst at Jefferies.
But for others, wary of the industry’s history
of violent boom and bust cycles, there will be
a temptation to lock in profits.
During the commodities boom of the 2000s,
the mining industry invested more than $900
billion of shareholder money on new projects
and deals to feed China’s seemingly insatiable
appetite for raw materials.
However, much of this new supply hit the
market just as growth in China started to slow,
sending prices — and with them the profits
of the biggest miners — into a tailspin during
2014 and 2015.
Chastened by the experience, the mining
industry spent the next couple of years cutting
costs, paying down debt and refusing to sign off
on new projects. But with commodity prices rising
as global growth accelerates, investors are worried
the industry could fall back into the old habits of
overspending and chasing market share.
“Miners need to convince investors that
returns are sustainable and avoid splurging
on excessive capital expenditure,” says Tal
Lomnitzer, deputy head of global resources at
First State Investments. “They need to find the
right balance between growth and returns to
shareholders.”
To that end, the sector’s reporting season,
which gets under way this week with annual
results from Rio Tinto on Wednesday, will have
a material bearing on the performance of the
sector this year.
Valuations are low, balance sheets are
strong, and fundamentals are positive. This is
the sweet spot of the cycle, and mining shares
should outperform again in 2018
Aided by higher commodity prices, the
Anglo-Australian miner is tipped to announce
the biggest dividend payment in its history
and top up its share buyback programme. But
equally as important will be the message Jean-
Sébastien Jacques, its chief executive, delivers
to shareholders.
Since he took the helm 18 months ago, Rio
has focused on generating cash and delivering
as much of it as possible to investors through
dividends and share buybacks. In the past year
alone, it has announced $8.2bn of cash returns,
putting the company ahead of many of its peers.
“We will allocate cash with discipline,”
Jacques told analysts and investors in December.
“As you know it’s a balanced allocation between
the strength of the balance sheet, long-term
growth — because we need to grow at some point
in time — and returns for the shareholders.”
Cementing in investors’ minds the idea
that miners can deliver consistent returns
while at the same time growing responsibly
will be key to driving a re-rating of the sector,
says Lomnitzer.
In spite of recent strong run, miners still
trade at a big discount. According to RBC
Capital Markets, the enterprise value of the
FTSE 350 mining index is 6.5 times prospective
earnings before interest, tax, depreciation and
amortisation. The wider MSCI World Index by
contrast trades on 10.
Another reason the sector could outperform
is the outlook for commodity prices.
Even though they have risen sharply over
the past year — copper has gained 20 per cent,
zinc 25 per cent and thermal coal 27 per cent —
there will not be a quick supply response with
miners suddenly able to ramp up production.
This is because the industry’s project pipeline
has been depleted by several years of costcutting
and austerity.
[Miners] need to find the right balance
between growth and returns to shareholders.
Ivan Glasenberg, chief executive of Glencore,
has stated he will not invest in new ‘greenfield’
mining projects, while BHP Billiton, the
world’s biggest mining company, has slashed
its capital and exploration spending from more
than $20 billion in 2013 to just $5.2bn last year.
Across the industry capex has fallen from a
peak of $160 billion six years ago to about $50
billion in 2017, according to Jefferies.
As higher commodity prices are reflected
by analysts in their profit estimates, this should
help push share prices higher, says Neil Gregson,
portfolio manager at JPMorgan Asset
Management.
“It’s probably going to be a year when the
sell side [analysts] are continually upgrading
earnings forecasts,” he says.
George Cheveley, portfolio manager at
Investec Asset Management, agrees. “If you
look at consensus forecasts and compare them
with current commodity prices you actually
have to factor in some pretty major falls not
to have earnings upgrades for a lot of the miners,”
he says.
The big risk to this optimistic outlook is the
ever-present fear of slowing growth in China.
However, analysts believe Beijing’s supply-side
reforms and war on pollution will help put a
floor under prices even if demand weakens.
In an effort to clean up its skies and improve
the profitability of bloated state-controlled
companies, Beijing has imposed supply constraints
on steel and aluminium production
and restrictions on copper scrap imports.
The environmental crackdown
has also hit domestic mine output.
Collectively, these actions
have helped support the price of
aluminium, steelmaking ingredient
iron ore, as well as zinc and
copper.
“The single most important
question for commodities is the
new environmental religion that
Chinese policymakers appear
to have caught and whether it
is structural or not,” says Nick
Stansbury, fund manager at Legal
& General.
“If it is, the implications are
massive and we are nowhere
near to pricing them in. They are
so much more far-reaching than
anyone realises,” he said.
Aside from China, perhaps the
other risk to further outperformance
will come from the urge to bank
profits, especially if costs start to pick
up because of higher oil prices and
the weakness of the US dollar. But
even here there are reasons to think
investors will stay the course.
“For those who have been in
from the bottom, psychologically
it’s difficult to believe share prices
are going to do more,” says Cheveley.
“But I think you have to look
past the gains in 2016 because it
was just a recovery from irrational
falls in the second half of 2015
and focus on the stronger balance
sheets and free cash flow that appear
sustainable through 2018.”
Shares in Anglo American,
which has a significant footprint
in South Africa, have risen 20
per cent since Cyril Ramaphosa’s
victory, outperforming the wider
market and its peers.
Ramaphosa, deputy president,
has already promised to review
a controversial industry charter
published by Zuma’s government
last year, which required at least 30
per cent of the sector to be owned
by black investors under measures
to redress sharp economic
inequality.
“If the mining charter is holding
us back, we must deal with
that,” Ramaphosa told this year’s
Davos gathering — addressing
concerns that the charter could
freeze investment by threatening
dilution for existing mining shareholders
in order to add new black
investors. Under the new charter,
previous black economic empowerment
deals are not given credit.
Ramaphosa added that he did
not want South Africa to miss a
commodities boom. Even during
the last one, South African miners
struggled to benefit because
of high labour costs and the difficulty
of overhauling ageing and
deep underground mines.
But while Ramaphosa is wellknown
to the industry — he
formed the country’s biggest
mineworkers’ union as an antiapartheid
activist, and later grew
wealthy on mining deals after the
ANC won power — much depends
on how quickly he could remove
allies of Zuma from control of
mining policy.
The architect of the charter,
Mosebenzi Zwane, Zuma’s mining
minister, will still be delivering the
welcoming address at the Investing
in African Mining Indaba, and
is unlikely to back down from calls
for it to be rewritten.
However, Zwane is implicated in
an investigation into the alleged influence
of the Gupta business family,
who are accused of using a friendship
with Zuma to control government
appointments and contracts.