Fair values cut across mining sector as boom comes to abrupt halt

Wavering demand, rising interest rates and supply chain problems have sent once buoyant commodity markets tumbling, in some cases at historic pace. However, analysts remain cautious about buying opportunities and tip further price falls.

Demand for fuel and metals, especially economic bellwethers like copper and iron ore, is falling and expected to decline further as central banks raise interest rates to battle surging inflation. Copper prices notched their worst quarter since the financial crisis in June. Benchmark crude oil prices briefly dipped below the key US$100 a barrel level in early July, although prices have since rebounded slightly.

Morningstar lowered fair value estimates across the resources sector in response, says director of equity research Mathew Hodge. He warned about further volatility and said the sector is far from trading at a discount.

“Commodity prices are moving around at the moment [and are] highly volatile,” says Hodge. “Some have been moving in generally positive directions – such as thermal coal – but many such as copper and iron ore have not. If sustained, these lower prices are a headwind to valuations.

“Commodity prices overall are still relatively elevated so by no means is the sector on sale.”

Fair values at BHP (BHP) and Rio Tinto (RIO) were reduced by 3% and 6%, respectively because of falling iron ore and copper prices. Both are trading in a fairly valued range. Diversified miner South32 (S32) saw its fair value slashed 19% because of lower aluminium and manganese prices.

Hodge now assumes iron ore prices will average US$110 per tonne between 2022 to 2024, down from an earlier forecast of US$148 a tonne as falling steel production in China crimps prices.

Lower copper prices cut 12% off Oz Minerals (OZL) fair value. Gold miner Newcrest (NCM) is the most undervalued miner, with a fair value of $33 compared to its price around $19.

Hodge says the outlook is brighter for thermal coal as Russian sanctions remove supply from the market at the same time as Europe mulls restarting coal-fired plants to cope with an energy shortage.

Morningstar fair value estimates for Whitehaven (WHC) jumped 73% to $9 a share while New Hope (NHC) saw its fair value rise 58%.

Value still not found in big miners

Investment bank UBS says the Australian resource sector isn’t cheap enough to justify sector-wide buying.

Upcoming production and financial results in August are likely to show higher costs and possibly lower production, with reduced rates of investment spending, “all reasons to be cautious and selective on buying,” according to an early July report titled, “Australian Resources Cheaper… But Not Cheap”.

“We remain Neutral on BHP, Rio Tinto and Fortescue Metals Group. Strong earnings near term should support returns despite higher costs, but downside to spot iron ore, copper, met coal and nickel prices will likely weigh on equities,” the note said.

In terms of other commodities including copper and aluminium, UBS says that slowing demand growth into 2023 raises the risk of weaker prices. “And while stocks have already fallen from recent cycle peaks, lower commodity prices would likely pressure equities lower still,” the investment bank says.

Long term case still strong

Goldman Sachs resources analyst Paul Young expects a drop in global commodity demand over the next 12 month as global economic growth slows. At the same time, rising energy and labour costs in the energy sector will squeeze profits from the other direction.

However, over the medium to longer term, Young remains positive on the mining sector. An expected recovery in China will lift infrastructure and property construction while global decarbonisation and investment in renewable energy projects is expected to result in a shortage of base metals, which will buoy prices.