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Contrasting outlooks for these 2 resource stocks

Glenn Freeman  |  24 Apr 2017Text size  Decrease  Increase  |  

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Both of these companies are leaders in their respective fields of mining and gas production, but Morningstar anticipates quite different earnings patterns for 2017 and beyond.


While mining company share prices have maintained their buoyancy longer than many analysts anticipated--including Morningstar's senior equity analyst covering mined commodities, Mat Hodge--the latest quarterly production figures from Rio Tinto (ASX: RIO) have not shifted his outlook.

"Our earnings forecast for 2017 is little changed ... and we maintain our $42 per share fair value estimate. Despite a near 15 per cent correction in the share price from the peak close to $70 in February, we still think Rio Tinto is overvalued," Hodge says.

He believes the market is not pricing in the likely structural demand weakness from China, with iron ore particularly exposed.

"We retain our high uncertainty rating, which reflects exposure to cyclical commodity prices, operating leverage and the firm's reliance on iron ore."

The miner's production in the first quarter of 2017 was slightly below expectations, however, this was somewhat countered by stronger realised prices for the year to date.

Shipments of iron ore from the Pilbara region declined 13 per cent quarter on quarter to 77 million tonnes, largely because of cyclone activity.

Copper output was also lower than anticipated, with guidance for mined copper production down around 12 per cent to between 500,000 and 550,000 tonnes. The company's Indonesian operations, with the Grasberg copper mine the world's second-largest, remain in a state of flux as Indonesian regulation disrupts activity.

"Continued uncertainty from the Indonesian government increases the likelihood that Rio Tinto may decide not to commit the funds," Hodge says.

"In our view, managing director Jean-Sebastien Jacques appears to be taking a prudent and pragmatic view towards the issue."

Natural gas

The immediate outlook for Santos (ASX: STO) is considerably more optimistic. While first-quarter 2017 production was down 2 per cent to 14.8 million barrels of oil equivalent (boe), this was in line with expectations, and Santos maintains all 2017 guidance.

Cyclone activity impacted production, as did the sale of the Victorian, Mereenie, and Stag assets--though stronger production from the Fairview and Roma gas fields offset this.

"We like Santos' focus on supporting five core, low-cost/long-life natural gas assets, all with significant upside potential," says Mark Taylor, Morningstar's senior equity analyst covering energy.

"Santos commendably reduced net debt by 15 per cent, or US$400 million, to US$3.1 billion over the quarter and will continue to prioritise free cash flow for debt reduction," Taylor says.

Both Hodge and Taylor will provide their detailed views on these companies and others in the materials and resources sectors at the next Morningstar webcast on Thursday 27 April 2017--don't miss your opportunity to register for this free online event.

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Glenn Freeman is Morningstar's senior editor.

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