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Are mining stocks overvalued?

Mathew Hodge, CFA  |  15 Jun 2018Text size  Decrease  Increase  |  
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We have been bearish on the resources space for a few years, and to date, our more pessimistic view has not played out.

The Australian mining companies have performed very well in recent times, against our expectations. From lows in January 2016, the S&P/ASX 200 resources index has roughly doubled, as have the share prices of BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). After plummeting 75% within two years, Fortescue's (ASX: FMG) shares have subsequently tripled from 2016 lows.

Based on our work on the sensitivity of our fair value estimates to commodity price changes, we estimate the market is factoring in current spot commodity prices in perpetuity, which we view as overly optimistic.

Moreover, for Rio Tinto and BHP, this implies average unadjusted returns on invested capital of about 16% for our forecast period, nearly double our estimated cost of capital for those companies given their lack of moat.

The market also discounts the potential for further bouts of capital misallocation. We continue to view shares as overvalued. At current share prices of about AUD 34 per share for BHP, AUD 85 for Rio Tinto, and AUD 4.70 for Fortescue, the shares trade at 48%, 77% and 27% premiums, respectively, to our fair value estimates.

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Mathew Hodge, CFA is a senior resources analyst at Morningstar. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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is Morningstar's director of equity research, Australia & New Zealand.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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