Trade tensions between the US and China are affecting Australian miners and oil and gas players in different ways, writes Nicki Bourlioufas.

With the current jump in the iron-ore price, some experts expect a jump in the share prices of the big miners BHP (ASX: BHP) and Rio Tinto (ASX: RIO) and a lift in their earnings. But any worsening in US-China trade relations and increased supply could weigh on their longer-term fortunes, experts say.

BHP is up 11 per cent over the year to 6 June, while Rio Tinto has climbed even higher, up 15.1 per cent – well above the S&P/ASX 200, which has gained 5.9 per cent.

Fortescue Metal Group (ASX: FMG) is one of the best performers on the ASX, up around 61 per cent year-to-date.

The companies have benefited from a higher iron ore price, which has risen this year on supply concerns. The rally was triggered in January after the world’s largest iron ore miner, Vale, reduced output after a disaster at its Brumadinho mine in Brazil. Prices jumped above $US100 a tonne in early June for the first time in five years on renewed concerns.

According to Morningstar senior mining analyst, Mathew Hodge, Rio Tinto and BHP Billiton are trading well above fair value, which he puts at $60 and $28, respectively. This compares to their current prices at around $96 for Rio Tinto and $37 for BHP Billiton.

Fortescue's share price of $7.80 on 6 June sits slightly above Morningstar's $5.70 fair value estimate.

“There has been a supply shock which has reduced supply by about 7 per cent in 2019. That’s mostly [due to] Vale and the tailings dam failure,” says Hodge. He expects the prices of the big miners to eventually fall back as supply increases.

Morningstar’s near-term iron ore forecast is US$78 in 2019, US$65 in 2020 and US$50 in 2020. Looking further ahead, Morningstar forecasts an iron ore price of US$40 from 2022.

Stockbroker Morgans also sees longer term risk for iron ore miners. “Longer term, robust iron ore prices risk attracting a supply response that would become an overhang once Vale recovers its suspended production. As steel prices decline, we see heightened volatility around iron ore as a large risk we cannot digest. We maintain our Reduce rating on FMG at these prices.”

In the short-term, however, the prices of the miners could rise still given an earnings boost from the higher ore price. According to a research note from Macquarie Wealth Management, buoyant iron ore prices will drive earnings momentum, with “material valuation upside at current spot prices”.

“We maintain our Outperform ratings on BHP Billiton, Rio Tinto, Fortescue and Champion Iron. Global supply remains under pressure while demand remains robust. The Australian iron ore majors are net beneficiaries of the supply disruption,” said Macquarie in a recent research report.

“At spot prices all covered iron ore miners see a substantial increase in forecast financial year 2020 earnings per share. BHP Billiton, Rio Tinto and Mineral Resources see fiscal 2020 earnings per share to increase by over 40 per cent each,” said Macquarie analysts.

Ewan Galloway, equities analyst at Perennial Value Management, says a deterioration in US-China trade relations could also have negative ramifications for Australian miners.

“Due to iron ore and coal accounting for 30 per cent of Australia’s exports, with China being the biggest buyer, any slowdown in Chinese growth and demand will be acutely felt by BHP and Rio.

LNG and tariff tensions

While US-China trade tensions pose a risk to Australian miners, they may actually benefit producers of LNG - which amounts to around 10 per cent of Australia's total exports. 

Galloway points to declining exports of LNG from the US to China, which have fallen 80 per cent year-on-year in 2019. He expects new LNG development projects may be delayed, further reducing demand, because of an inability to secure long-term contracts from Chinese buyers.

"This could increase the willingness for Chinese buyers to turn Australian exporters and underwrite expansion projects like Woodside’s Pluto Train 2 to fill the demand gap," says Galloway.

Morningstar senior equities analyst Mark Taylor agrees. “Woodside is potentially a winner from US-China trade tensions. China may preference Australian gas to the US Gulf Coast.

"But if trade tensions ease, increasing the US portion of LNG into China may be a logical way for China to ease the surplus with the US, which would not be so good for Woodside and other Australian LNG players," Taylor says.

He gives Woodside a fair value estimate of $46.50, above its share price of $34 on 6 June, and believes the stock has been oversold.
“Chief concerns revolve around market demand for more gas, agreement from a complex joint venture partner structure and execution risk on large projects. We think all concerns [are] overdone.”