Mining fair value upgrades in view amid soaring commodity prices
BHP, Rio Tinto and a slew of smaller miners stand to gain if the supply shock to commodity markets persists.
Morningstar resource analysts are mulling big fair value upgrades across the Australian mining sector should today’s record commodity prices stay elevated this year.
Mining heavyweights BHP and Rio Tinto, as well as specialised miners like Whitehaven Coal, could see fair values upgrades ranging between 10% to 100% if prices for coal, iron ore and other industrial metals hold onto their breakneck gains in 2022, according to new analysis published by Morningstar last Thursday.
Fair values remain on hold for now, but upgrades will follow if prices stay this way for much longer, says Mathew Hodge, Morningstar director of equity research.
“If prices stay where they are, it’s obvious there is upside to fair values and valuations in the market,” he says.
“We make no changes to any of our fair value estimates for the miners for now but intend to factor in a potential supply shock to our valuations soon, where relevant.”
Russia’s invasion of Ukraine and the retaliatory sanctions have sucked critical supplies out of already-tight commodity markets and sent prices for some ores soaring as high as 150% relative to last year’s prices. Hodge compared the supply shock to the 2019 Vale tailings dam failure, which killed hundreds and took more than 5% of iron ore supply offline for years.
Industry analysts are scrambling to update price forecasts in response. Investment bank Macquarie raised price targets for BHP by 15% and Whitehaven Coal by 100% last Friday in line with upgraded price forecasts for iron ore, base metals and coal.
Thermal coal is likely to be hit hardest by supply disruptions, says Hodge. Russia accounts for roughly 15% of global trade and supply has also been hampered by environmental concerns. Newcastle thermal coal futures closed on Friday at US$418.75 per tonne, up 76% since the 24 February invasion. Prices averaged US$137 through 2021.
Fair value estimates for local producers Whitehaven Coal (ASX: WHC) and New Hope (ASX: NHC) would nearly double should prices hold these levels for a year, says Hodge. London-based diversified mining giant Glencore (GLEN) would see its fair value rise by 20%.
In a scenario where coal prices ease to US$280 over the same period, fair values for Whitehaven and New Hope would still jump by nearly half.
“Current record prices above US$400 per metric ton would not have to be sustained for long for our fair value estimates to be pushed higher,” he says.
Iron ore is also at risk of supply disruption, with Ukraine and Russia producing 4% of global supply, or just under two-thirds of what was lost during Vale’s tailings dam failure.
If iron ore prices hover around the US$160 mark through 2023, fair values for Fortescue Metals (ASX: FMG), BHP (ASX: BHP) and Rio Tinto (ASX: RIO) would rise by between 10% and 30%, says Hodge. BHP would also benefit from elevated prices for metallurgical coal, used in steel making as opposed to power generation.
Producers South32 (ASX: S32), Glencore and BHP would also see fair value lifts between 1% and 3% should last week’s record nickel prices persist for a year. Hodge thinks it unlikely and says those prices were an “anomaly”.
Nickel trading on the London Metal Exchange remains shuttered after prices more than doubled to above US$100,000 per tonne last week amid a short squeeze on Chinese metals tycoon Xiang Guangda.
Things could change quickly
Enormous uncertainty remains around the longer-term impact of Russia’s invasion of Ukraine and the subsequent sanctions, says Hodge. Unlike standard supply shocks, Russian production remains intact, and a peace deal could see it flood back into markets. Chinese buyers could also pivot to Russian commodities and ease demand elsewhere.
“It could very quickly change if something happens to Putin, or if there is some sort of truce and they [Western nations] agree to unwind the sanctions,” says Hodge.
In a sign of how quickly market expectations of the supply-demand balance can shift, many commodity prices retraced last week’s gains on Monday as China locked down tens of millions in the key manufacturing hubs of Shenzhen and Changchun in response to covid outbreaks. Investors are concerned about demand slowing in the commodity-hungry country that consumes three-quarters of all iron ore and half of copper.
The Bloomberg Commodity Index, which tracks 23 commodities, fell 2% on Monday. Iron ore lost 6.2% to US$144.90 per tonne. Brent Crude finished at US$106.90, down 18% from highs above US$130 per barrel notched last Wednesday. It remains 11% above pre-invasion levels.
“Price is set at the margin. If you’ve got tight markets, small changes can have a big impact on price,” says Hodge.
“These prices are generally in rarefied air, there is nothing supporting them fundamentally. If there is more supply than demand or if demand drops, prices can drop a long way.”